The global market has become a place for lots of transactions- of various types. There are more businesses set up, and various dealings added to the stock market. One major aspect of the global stock market is the foreign exchange market. Overtime, it has grown into one of the major sources of revenue to the global economy. It has become a major investment opportunity for various investors and brokers. However, due to a latency loophole; more investors are starting to employ the use of High Frequency Trading (HFT) systems.1
These HFT systems are automated trading platforms that use powerful computers to perform numerous transactions- at very high speed. They use machine learning algorithms to optimize trading on various levels. For each investor that employs an HFT, they need not do total supervision of the trading process. It also gives them an edge, compared to other traders because they can perform at a higher speed and efficiency rate.
One major aspect through which HFT investors benefit is called Latency Arbitrage. The Latency Arbitrage is an act where an investor, usually an HFT firm, exploits time disparity and gains profit due to latency advantage. Latency advantage is the delay in already existing transactions between two parties. It is what Latency Arbitrage uses; as HFT investors can take such transaction, complete it and gain profit. Due to how unfair it seems; people sometimes feel it is an illegal act, however, it is not.
The major reason why the latency advantage exists is due to latency disparity. This refers to the difference in time which investors receive publicly traded stock data. It is why the HFT investors pay large sums to gain premium data feeds- ultimately to reduce latency. However, not all investors can procure HFT services; thereby leaving them at a latency disadvantage.
Definitely, the currently existing mode of operation, and structure of the stock market adds to the existing latency disparity. However, there are also a number of existing reasons why latency exists. One of them is the Securities Information Processor (SIP) speed- it involves the passing of stock market data to all investors. Another reason is that many of these investors move their equipment to the servers that distribute data. Therefore, they receive the data and can perform at a faster rate.
The SIP is an AI Bot; built to consolidate stock market data, and send- at once –to all investors. To consolidate data means to collect and integrate data from various sources into a single file. After data consolidation is done, the SIP moves on to data distribution for each investor. Although direct data would be faster to process than processed data, the SIP aims at more efficient data for investors to work with. However, the issue with the SIP concerning latency disparity is not due to the time required for this process. Instead, it is in the moving of data to various investors because these investors are variedly distanced to the main source.
A major question however is; who does latency disparity affect the most? A direct answer for this would be the investors- those without HFT systems. Investors, that do not have the funds to move their equipments or subscribe to HFT platforms, are the ones most affected by the latency disparity. They get data at a later time than their competitors, due to latency arbitrage and therefore cannot earn as much. Basically, this means that some investors suffer because of how expensive Latency Arbitrage is.
Latency Arbitrage also takes its toll on the stock market, as these factors result in an unbalanced National Best Bid and Offer (NBBO). The NBBO refers to the regulation that requires brokers to perform trades at the lowest sale price, and sell at the highest bid price. This ensures that there is an accurate price for each stock across the market. However, due to Latency Arbitrage and lack of uniformity in information, prices can be altered by HFT investors- thereby altering the NBBO.
Lots of loopholes, that can be capitalized, do exist in trading. However, some of these loopholes are due to the upper-hand, given to big stock investors. Also, the use of HFT platforms makes the balance tilt towards the big spenders in stock investment. It results in an altered system and a flawed market for all customers. Although it alters the stock market and makes it unbalanced, Latency Arbitrage is not illegal. Ultimately, it is proof that it takes capital to earn money and a bigger capital to earn more money from a business.