Fast or Focused? Making Low Latency Accurate
Smarter latency: Risk and rewards
The smarter latency benefits for a price taker include:
- Higher fill rates: Visiting as many lit and dark venues, by focusing on all levels of liquidity and hunting for hidden liquidity.
- Lower cost: Avoid paying expensive fees for co-location, mixing execution on different venues with competitive price structures, examples include rebates offered by the ECN/MTF for passive orders, and by tapping into liquidity venues, which provide special liquidity, such as dark pools.
- Lower risk: Putting more risk management in place for managing position risk, but also execution risks, which is inherent with millisecond machine-to-machine interaction (e.g. a rogue algorithm would be able to quickly create a huge number of unwanted orders/quotes before ahuman can detect it).
Such results can be obtained through algorithms and smart order routing applications focusing more time discovering higher quality liquidity (e.g. level 2 prices across different lit venues and dark pools), minimising costs and fees incurred at a lower risk.
The debate is clear; it is inevitable the exponential increase in trading speeds, albeit at a less aggressive pace, will continue as technology evolves. However, this creates systemic risks that are too important to neglect, as the Flash Crash bore witness to. HFTs, and in particular, market makers, have an essential role in the health of the market, by
providing liquidity and lowering spreads, but an onerous clampdown of these market participants would harm the market, rather than cure the risks it has created. Liquidity providers benefit from simple algorithms and very fast infrastructure, yet this is to the detriment of price takers, who are the majority of market participants.
Smarter latency is the response to systems that have been designed with one single purpose, latency reduction, which often delivers a poor level of performance and a high degree of risk.
Investment in key technology platforms, by all market participants, namely, the buy-side, sell-side, exchanges, but also regulators, would establish a reasonable risk managed market. Smarter latency would enable primarily price takers to further benefit from the market today through the addition of intelligence to the more latent components of the trading ecosystem.