There has been much discussion recently around the impact of high frequency trading (HFT) on the financial markets. There is no doubt that the concept of HFT, analysing market information such as stock prices to implement proprietary trading activity in a matter of seconds, has many advantages. This includes greater market liquidity, lower transaction costs and faster access to pricing.
However, until recently, HFT has only really been active in equities and derivatives. Today, we are seeing a fundamental shift of HFT into other asset classes such as foreign exchange (FX), as traders search for new ways to achieve greater liquidity during these unpredictable economic times. It is easy to see why demand is high, a low margin of relative profit is an attractive proposition for any trader. Although, not everything has been plain sailing for HFT in FX. For example, in March this year, we witnessed a crash of Japanese yen in FX following a computer programming trade order that went wrong and distorted the markets. As a result, this caused liquidity in the FX market, which trades billions of dollars worth of currencies daily, to instantly grind to a halt.
The sheer scale of the Japanese crash is clear evidence that there is a high demand for FX transaction volumes with HFT. Therefore, for traders selling FX investment services to asset management companies, the speed and optimisation of price setting is imperative. This is because speed of prices in a highly volatile and unpredictable market is critical to perspective buyers. Without this, they are unable to make well informed investment decisions.
This is where low latency comes in as a key factor when setting pricing. Latency has traditionally been one of the most unspoken aspects of trading currency, often because traders only care about what prices are immediately on their screen, and not how it gets to their desktop in the first place. It is also important to point out that within FX, everything is traded over the counter (OTC), a little bit like derivatives. This is because there is no physical trading location or exchange. Indeed, there is a certain irony in the fact that there is no ‘exchange’ in foreign exchange.
The points above, together with the time zone and geographical scattering of FX, means that the locations of the servers in relation to the data centre is a major key to future HFT success in this particular asset class is. The most effective way to limit latency is to make sure the physical location of the trader’s servers is in close proximity to the data centre. For example, our own London arbitrage centre, which is the hub of FX trading operations, uses fibre optic networks to provide ultra low latency. As a result, traders canprofit by providing competing pricing bids faster than their competitors. So, as HFT activity continues to accelerate, the question should be, which asset class is next to come under the HFT spotlight? One thing is for certain, FX is not the first and certainly won’t be the last asset class to be impacted by HFT. If there is liquidity available, some bright spark in the square mile will find new and innovative ways through technology to find it.