Ultra Low Latency Trading | HFT System Design
Introduction
In this article, we’ll explore how High-Frequency Traders (HFTs) build ultra-low latency systems to achieve tick-to-trade latencies in the order of nanoseconds. Much like an F1 race, where the fastest car and the best driver win, HFTs rely on top-tier hardware, skilled traders, and talented engineers to stay ahead of the competition.
Understanding the Importance of Speed
In high-frequency trading, speed is everything. The faster your system processes market data and submits orders, the better your chances of profiting. Just as in an F1 race where every millisecond counts, HFT firms must minimize latency to win the race against other trading firms.
Latency can be affected by several factors, including the physical distance between the trading firm’s servers and the stock exchange’s servers. The closer your servers are to the exchange, the faster your data travels. This is why many firms choose to colocate their servers within the exchange’s data centers.
Market Data Processing and Order Execution
When a market event occurs, such as an order being placed, modified, canceled, or filled, the stock exchange sends out market data. This data is received by the HFT firm’s market data application, which processes it, updates the order book, and passes it on to the trading strategy. The strategy then decides whether to buy, sell, or take no action.
Once the decision is made, the order entry application sends the order to the exchange. Market data typically travels via UDP, while orders are sent using TCP. Both are encapsulated in IP datagrams at layer 3 of the OSI model, which are then encapsulated in Ethernet frames at layer 2, traveling on the physical link layer (layer 1).
The Role of Co-location
To minimize latency, many HFT firms colocate their servers within the exchange’s data center. This means placing their servers as close as possible to the exchange’s matching engine, where trades are processed. In a co-location facility, all trading firms have an equal one-meter cable connecting their servers to the exchange’s matching engine, ensuring a level playing field.
However, light doesn’t travel in a straight line within the wire; it zigzags, slightly increasing the travel time. As a result, the effective latency of a one-meter wire is around 4.97 nanoseconds, according to Optima.
Challenges and Costs
Co-locating in the exchange’s data center is not cheap. The space, hardware, and connectivity come at a high cost, making this option feasible only for large firms. Smaller firms may use third-party data centers, their in-house facilities, or public cloud services like AWS or Microsoft Azure. However, these options come with higher latency and potential risks, such as maintenance outages or physical damage to underground cables.
Fairness and Regulation
The stock exchange must ensure that market data is distributed to all participants simultaneously. Any favoritism can lead to unfair advantages and legal consequences. A notable example is the NSE co-location scam in India, where certain market participants received data earlier than others, allowing them to front-run the market. This led to significant legal actions and ongoing investigations.
Conclusion
In the world of high-frequency trading, success depends on ultra-low latency systems, skilled professionals, and strategic co-location within exchange data centers. The costs are high, but for the biggest firms, the rewards are worth it.
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