Network-induced latency, a synonym for delay, measured in one-way delay or round-trip time, is normally defined as how much time it takes for a data packet to travel from one point to another. Low latency trading refers to the algorithmic trading systems and network routes used by financial institutions connecting to stock exchanges and electronic communication networks (ECNs) to rapidly execute financial transactions.Most HFT firms depend on low latency execution of their trading strategies. Joel Hasbrouck and Gideon Saar (2013) measure latency based on three components: the time it takes for
- Information to reach the trader,
- The trader’s algorithms to analyze the information, and
- The generated action to reach the exchange and get implemented. In a contemporary electronic market (circa 2009), low latency trade processing time was qualified as under 10 milliseconds, and ultra-low latency as under 1 millisecond.
Low-latency traders depend on ultra-low latency networks. They profit by providing information, such as competing bids and offers, to their algorithms microseconds faster than their competitors. The revolutionary advance in speed has led to the need for firms to have a real-time, colocated trading platform to benefit from implementing high-frequency strategies. Strategies are constantly altered to reflect the subtle changes in the market as well as to combat the threat of the strategy being reverse engineered by competitors. This is due to the evolutionary nature of algorithmic trading strategies – they must be able to adapt and trade intelligently, regardless of market conditions, which involves being flexible enough to withstand a vast array of market scenarios. As a result, a significant proportion of net revenue from firms is spent on the R&D of these autonomous trading systems.