How Does Latency Impact Forex Trading?
There is an intrinsic link between low latency and financial advantages in the FX industry. Professional traders rate latency as a crucial factor in the success of their trading strategies. It is the importance of low latency for retail and institutional FX traders that has spurred technical innovation across the industry of IT colocation providers, innovators and special telecommunication providers. The race is on to drive the fastest data transmission.
Latency can be defined as the delay or lapse in time between an order request and the execution of the order. The speed at which traders access information and analyse the market, then communicate the order to the broker, who executes it at the desired price is the key to long term profitability. So, low latency connectivity is important to ensure that the time taken to complete the entire process is kept at a minimum.
The Nature of the Global FX Market
Forex is a decentralised marketplace. Trading in this market includes processing orders on a global scale. Different currencies come into consideration and decisions are made based on the aggregate of market data coming from New York, London, Singapore, Tokyo, Sydney and everywhere in between. Data is collected from all major hubs globally, so naturally there exists an inherent latency within this process.
Many causes of data lag cannot be controlled by a trader. Excess latencies can be present in internet connections, brokerage servers, exchange servers or in the trader’s computer hardware or software. These occasional problems with hardware or bottlenecks in exchange data transmission often go unnoticed. Slow internet connectivity can delay the whole process and make strategies go haywire.
So, the concept of minimum latency becomes important in FX trading to gain a competitive advantage, and traders strive to find high-performance trading platforms that have a low latency rate. The support of a reputed and regulated broker is also paramount, as traders cannot handle all technical problems on their own.
The Concept of Negative Slippage and Requotes/ Off-Quotes
Latency between order requests and actual execution causes slippage. Here, the trader’s orders get filled at a price that is different from the desired level, either higher or lower. When prices are frequently filled at disadvantageous rates, it leads to negative slippage. This can be a result of intense market volatility, following the release of an economic indicator or any other breaking news. Often trading assets with low liquidity also increases the risks of negative slippage. But, high latency can also be a cause of negative slippage. This can compromise many trading strategies, leading to lower long-term outcomes.
Furthermore, latency is a problem when traders have to deal with re-quotes and off-quotes. Requote is when brokers have to place orders at different prices than what the trader expected. Off-quote means that the broker is no longer able to execute the order, since the trade is no longer viable, based on the requested price.
Technical architecture of a trading terminal has to be robust to prevent this latency. Transactions have to be facilitated at high speeds, particularly for highly volatile currency pairs, like the EUR/GBP or AUD/JPY.
Managing Latency Issues
In this fast-paced global FX trading environment, high latency is a total dampener. Low latency is essential for creating liquidity, reducing spreads and lowering the overall cost of trading. At the same time, the market is constantly changing, which makes factors like transparency and quality of execution pricing very important to the trading policy of firms.
Firstly, there needs to be a greater emphasis on improving the efficiency of the trading processes, rather than just the speed. This can include complete audits of trading policies, operational and compliance risks and the overall strategy and process. Full order execution with minimal information leakage is also a priority for many financial traders.
Looking at the technical aspects, one way in which high latency is managed is through direct market access (DMA). The buy-side firm here has direct connection to the order book at the exchange. Several steps in the order routing process are eliminated this way, which means that orders reach the exchange quickly and are executed ahead of others. Till quite recently, DMA access was reserved for institutional traders, but now it is becoming available for retail trading as well. This way of placing orders provides greater flexibility and transparency.
Another way to reduce latency is choosing to trade with an ECN broker. ECN stands for Electronic Communications Network. This is used by a broker to give clients direct access to other participants in the forex market, including top-tier liquidity providers. ECN brokers consolidate quotes from several market participants to offer clients the tightest bid/ask spreads. Price feed transparency is another advantage of ECN systems. All ECN brokers have access to the exact same feed, which means less risk of price manipulation.
To trade with minimal latency, forex traders require 24/7 high-speed internet connectivity and minimal system errors or hardware failures. Forex VPS (Virtual Private Server) hosting could be a good solution to this problem. Everything is virtualised, so traders do not have to worry about traditional hardware issues that could hinder trading results. They can rely on a dedicated server, anywhere and anytime they trade.
Even during power outages, automated systems keep on working on the VPS, which means that trades are continuing, regardless of the trader’s online status. Slippage can be avoided. Forex VPS has become very popular, especially for traders who rely on Expert Advisors (EAs). EAs are installed on the VPS itself, so orders are instantly sent to the MT4 or MT5 servers autonomously.
Latency is a crucial aspect of FX trading success. It is helpful in multi-asset strategies as well. The role of a great broker with technical competence is unquestionable, but traders need to follow certain steps on their end as well. This includes regularly updating computer software and hardware, performing “ping” tests with brokerage servers to measure internet connectivity speeds and evaluating trading performance on a daily basis. To compete in the digital marketplace, addressing all the variables that affect performance is important.