Technology Enablers of Latency Arbitrage

Ralph Frankel, CTO of Solace Systems, has a fascinating article on the technology for shaving microseconds and milliseconds off the market-response time they can achieve for high-frequency trading functions. He classifies “tricks of the trade” into five categories, each incorporating sophisticated specializations that combine to provide a significant edge. (And aptly labels this latency arbitrage, as distinguished from statistical arbitrage and any other technique that might be employed in algorithmic trading.)

He concludes by raising the question: “Is latency arbitrage fair?”, ultimately answering with “Yes—if you’re willing to invest in the same technology”.

The engineer in me is deeply impressed with what the systems from Solace can apparently do. The economist in me is horrified by the waste of resources and talent. Never mind fairness–the latency reduction arms race entails substantial costs (a boon for Solace Systems), but no consequent benefit in overall market performance. The situation gives us a choice to pay the transaction cost in computer software/hardware, or in latency arbitrage, but either way it’s a transaction cost.

(Thanks to the Felix Salmon blog for the link to Frankel’s illuminating article.)