What is Latency?

Education /
Axi Team / 06 Jun 2016

Beginning in June, AxiTrader is launching a series of articles and expert commentary about trading technology, the impact it has on your trading and what you can do to improve it. This is part of our ongoing commitment to ensuring our clients have the best resources and information to help them succeed with their trading. What follows is the first article in the series, outlining the concept of latency. 

You might hear the term ‘latency’ being thrown around when you talk about trading, but do you know what it is and why it’s important?

Many traders just watch the markets move up and down, waiting for the right opportunity to enter or exit a position. They click a button, the order disappears into MT4 to get filled and, somewhere along the line, they end up with a profit or a loss. But have you ever wondered what really happens when you place a trade with your broker? Have you noticed that sometimes the price a trade gets filled at is slightly different to the price on the screen? If so, you need to know about latency.

Latency is essentially the time between an order being placed and the point at which it is filled. This is a very small amount of time, measured in fractions of a second, but in a market characterised by volatility and where price movements are measured to five decimal places, even a tiny difference can have a big effect over the long term.

How to hear latency

To help explain the concept of latency, heres a very rudimentary example:

Lets say youre sitting next to someone at home having a conversation. As you're speaking, the other person can hear you and process the information as its given out. Youre right next to them so communication is immediate, with no interference.

But what happens if you walk down to the other end of the house and try to have the same conversation? The message has to travel that little bit further, maybe around corners or through walls, so youre probably going to have to raise your voice to communicate effectively with the other person.

So what happens if you then went to another room on a different floor? Now theres even more distance and even more obstacles in the way. The further you get from the person talking, the more obstacles there are to prevent your message from getting through quickly and clearly.

While thats an extremely simplified example, the fundamental principle is the same: latency is the delay between the time you send the message to the time it is received. The further your message has to travel, the longer it takes to get there, so the higher the latency. This is even true in trading, where your data travels through cables at the speed of light.  

The journey of a trade to the MT4 server

To get a better appreciation for latency as it relates to trading, it helps to have a rough understanding about how electronic trades are actually processed.

At a very basic level, you hit a button to place a trade in MT4 on your computer or device, it travels through the Internet until it gets where it needs to go, executes your trade and thats all there is to it. But, of course, its rather more complex than that.

Youll probably know from experience that online connectivity isnt a uniform thing. Some places have a fast internet connection while others can be slow, and thats largely down to the infrastructure available to you. The internet, rather than being a single entity, is actually a vast series of disparate connections, some more reliable than others. For your little packet of trade data to make a trip across the internet, it might involve travelling through cables in your street, phone towers, underwater cables, satellites and more. And as your trade navigates through all this infrastructure, it jumps quickly from one connection point to the next in order to find the fastest route to get where it needs to go. On such a journey, each movement between points is called a hop.

As all this hopping is happening, market prices are fluctuating. If your little packet of data can find a fast route through cyberspace that is, one with fewer hops youre going to experience lower latency as therell be less time for the markets to change from the time you click to confirm the trade. But if your data has to travel via a less efficient route maybe a part of the network is down so it has to go the long way, or maybe there is congestion transmitting across an ocean cable, or maybe youre trading on your phone in a remote area away from reliable coverage, or maybe someone in your house is using up your bandwidth by streaming video then the latency is going to go up, as will the potential for differences in pricing.

How do you improve latency?

Having lower latency generally requires investment in infrastructure. If you have powerful servers, a fast internet connection and high spec computers or devices, youre giving yourself a technological edge when it comes to trading in volatile markets. But even if youre not able to make those sorts of investments, there are some reliable solutions.

Because we know that less hops means less latency, it stands to reason that if you could physically plug your computer into the MT4 server, youd be getting a direct connection for your trades to travel exactly where they need to be. Of course, thats not very practical, which is why brokers like AxiTrader offer whats known as a Virtual Private Server (VPS).

These VPS servers are located in the best place they can be: right next to our MT4 servers, connected via a fibre cable, meaning your trades travel at the speed of light to our MT4 servers. You can run your trades via the VPS which means youve got a kind of personal highway directly from your platform into the main servers. With less traffic on this highway, youve effectively got guaranteed low latency 24 hours a day. That makes VPS solutions very popular, especially for professional traders and traders running Expert Advisors or Algorithms (essentially, automated trading).

Latency and your bottom line

Now that you know just a little more about how trading infrastructure works behind the scenes and behind the screens, hopefully its not hard to understand how its possible to end up with small differences between a quote price and execution price of a trade. Its a fast moving market and, unfortunately, not all technology is able to keep up with it.  

The key thing as a trader is to equip yourself as best as possible to mitigate any potential negative effects of higher latency. Try checking with your broker to see how their latency compares, aim to trade at times when youve got optimum internet connectivity even downloading a movie while trading is going to slow you down opt for a physical cable connection rather than wifi, or try a VPS solution.

The more knowledge you have about all aspects of trading technology, the better placed you’ll be to start profiting from it.

Simon Turner CIO AxiTrader.

 

 

The information provided here has been produced by third parties and does not reflect the opinion of AxiTrader. AxiTrader has reproduced the information without alteration or verification and does not represent that this material is accurate, current, or complete and it should not be relied upon as such. The Information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any particular trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.

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