Budgeting for Latency: If I Shave a Microsecond, Will I See a 10X Profit?
January 11, 2010
As 2010 starts, it's no longer enough to be able to evaluate risks, check market conditions and adjust trading strategies fast enough to send out thousands of buy and sell orders a second.
If you want to beat the next outfit to the punch by a millisecond or a microsecond-as many high frequency traders aim to do-you're going to have to constantly wring out bottlenecks and delays in the way your instructions get sent to and executed by the various exchanges.
Enter the demanding exercise now known as latency budgeting.
High-frequency, low-latency tra-ding now accounts for 70 percent of all trading in equities, according to Aite Group. The high-frequency trading unit of the Chicago hedge fund Citadel Investment Group raked in almost $1 billion in trading profits in 2008 from the practice. And its 2009 numbers aren't in yet.
But the message is clear: Numbers like these mean that for those traders whose strategies require the highest speed of performance, every millisecond matters. And unless you manage by the numbers, lowering the latency in your trading systems every year, every month and every day, you will not be able to compete with better, more vigilant managers of latency "budgets."
It's not just time that must be budgeted. Time also is money. Buy side and sell side firms each must keep careful watch on IT costs. Because each microsecond saved has a calculable cost. And, in the words of the rock standard, it keeps getting higher and higher.
"The cost of lowering one's latency on any given component of the trading operation is rising. In particular, we see this trend in co-location costs and, for that reason, there is greater focus on the total latency management process," explained George Hessler, executive vice president at New York-based Lime Brokerage, an agency broker that works with many high-frequency trading firms.
Co-location has installation, maintenance and rental costs, as firms try to put their execution systems as near as possible to venues' matching engines. But every aspect of high-frequency trading matters.
"Latency budgets only truly came into vogue in the last four or five years. That's when we saw purely electronic trading or trading without a person in the mix," says Matt Meinel, global director of business development at 29 West, a Chicago-based provider of ultra low latency messaging platforms and solutions. Once automated trading systems got combined with electronic exchanges, the performance limits associated with human interaction were removed, he said. And the bar inevitably got raised on trading performance.
TIME IS TIGHT
Simply defined, a latency budget is kept in order to assess, monitor and then manage how much time a firm expends on each and every step of the trading process, in both seconds and dollars.
For a broker-dealer or hedge fund measuring equity trading, what gets watched is the round-trip time of an order-how long it takes for trading data to travel from your servers to an exchange's matching engine for execution and then back again.
This is sometimes referred to as end-to-end latency. The less latency, the faster trades are executed and the more trade fills you will see.
Alternatively, if you are an exchange, you are analyzing latency from the time you receive an order to the time you send a filled order back. This is door-to-door latency.