The Low Latency Advantage in Online Trading

[BarrySDCA]

The Low Latency Advantage in Online Trading

Latency is arguably the most important and often disregarded factor for the online trader. It is often neglected because it sounds like a complicated computer term, but understanding what it is can quickly and substantially increase the trader’s earnings. Computer networks communicate by sending packets of data through the Internet. Latency is the time required for data to travel from the source to destination network. It is measured in milliseconds, or 1/1000th of a second.

It is a public misconception that everyone enjoys the same Internet. Data traveling over the Internet can be compared to delivery vans on the road carrying packages to their recipients. The recipients of the packages are all over the world, and so some delivery vans must travel a lot farther than the others in order to reach their recipients. Some experience delays due to detours and traffic jams. Others experience lost or damaged packages and need to restart the delivery again at the expense of time. The delivery van that travels only a city block or two will get to the destination first and with little chance of damage to the packages. This is because the other delivery vans travel hundreds or even thousands of miles farther to reach the destination, which increases the time required to deliver the package and likelihood of a problem or detour along the way.

With online trading, latency is even more crucial because data must travel round trip to make a single transaction. That is, a price quote must travel from the broker ’s server to the trader’s VPS to be processed and then the data must travel the same distance back to the broker ’s server to enter or adjust an order. Since the market waits for nobody and will continue to move while price quotes are in transit, the trader with the lower latency VPS will always have a more true and real-time reading of the market then the trader with a higher latency VPS. If the market is volatile and latency high then the price quote may not be “fresh” when it is finally received by the recipient.

The financial advantage of a low latency VPS over any other VPS can be staggering to the trader. To understand why, we only need to adjust our previous example to better reflect the real chain of communication in an online trading scenario. That is, data must travel from the broker to the VPS and back to the broker .
Imagine two traders; one is located in an office two city blocks off Wall Street and the other in a costume shop 880 miles away in Atlanta, Georgia. Both are using the same NYC broker . For the purposes of this illustration, imagine the price quotes and orders are sent by taxi from the broker to the trader and back.

For the first trader in NYC, the data must only travel from the broker down the street two blocks. That trader then sends the taxi back another two blocks with instructions for the broker to open or edit an order.

Although both taxis left the broker at the same time, the second trader will not receive their same price quote before the first trader has already sent their taxi back and entered an order with the broker . This is because the second taxi must travel an additional 880 miles just to deliver the price quote – the first ½ of the round trip . It must then make the return trip back – all while the market continues to move during their journey to the destination. The first trader will have completed many round trips for every one made by the second trader. During periods of volatile market activity, the price quote received by the second trader may not even be current due to the longer time required to deliver data. Clearly, the trader only two blocks away from the broker has a tremendous advantage over the other nearly 900 miles away.

Although data really travels much faster over the Internet then cars do on the road, the distance data must travel and the time advantages are virtually the same in real world online trading. The result is that the trader closer to the broker will receive price quotes and execute orders significantly sooner and with fewer errors then any other trader, and always have the most current representation of true market conditions.

...Read the entire article here