Latency Arbitrage

Publication Date :

05 Jun, 2025

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Table of Contents

What Is Latency Arbitrage?

Latency arbitrage refers to a high-frequency trading method used to make profits. It leverages the information dissemination speed difference between high-frequency traders and slower trading investors. It aims to implement faster trades than other traders or brokers to profit from the price difference.

It’s directly dependent on the latency of computer signals, comparing their speed from one place to another. Big institutional investors use breakneck internet speeds and high-performance computers to make latency negligible to acquire real-time stock prices. They exploit minor price discrepancies to trade for profits.

Key Takeaways

Latency arbitrage is a strategy of HFT capitalizing on speed discrepancies between traders. It allows faster trades execution to exploit price differences to make profits.
The method aims to leverage transaction rapidity to take advantage of slower brokers or investors in the market to make profit price variation.
It turns out to be a highly profitable trading strategy for HFT institutions.
Still, it carries a high risk due to potential software glitches due to any plausible glitches or errors in the software or speed that can take out all profits from the trade.
Trading algorithms mitigate its effect and co-locate servers, among others.

Latency Arbitrage Explained

Latency arbitrage trading can be stated as a unique trading strategy where traders profit from differences in the latency of price information reaching different market participants. The latency happens for different reasons, such as the distance between the trader's computer and the broker's server or the slower speed of the internet due to network jams. As a result, it takes more time to reach the signal from the source to the destination, leading to price differences between different destinations with respect to the source.

Large institutional investors and brokers fully exploit these latency factors to make profits by deploying high-frequency trading (HFT). They deploy huge sums in superfast network infrastructure and decrease the physical proximity between their servers and stock exchange servers. Further, some organizations or brokers even install servers on exchange campuses, termed as co-location, after paying hefty amounts to exchanges in return.

Hence, they are able to get real-time updates of stock prices within fractions of milliseconds, unlike other traders or investors with slow internet speed or located far away from the exchanges. Consequently, it transforms into slight price differences between slow traders and large institutions with the fastest internet and co-location differences. Some institutional investors & high-frequency trading firms using HFTs utilize tiny stock price differences to gain smaller profits per trade. However, when such profits get compounded over millions of HFTs, it becomes a significant amount of profit.

However, some brokers consider latency arbitrage as an abuse of infrastructure and location, particularly in the context of forex trading. Traders utilize high-end forex latency arbitrage software and co-location advantages to execute trades faster than others, which raises concerns among brokers about fairness and market integrity.

Examples

Let us use a few examples to understand the topic well:

Example #1

Let us assume Abby, a retail investor, monitors live currency exchange and notes USD/EUR at 1.1000. Meanwhile, highly sophisticated and large institutional investors with cutting-edge technology and co-located servers continually scan stock prices. They exploit any slight price differences between various stocks using the latency arbitrage strategy.

Hence, as soon as Bank A in London quoted a slightly higher euro at the selling price (1.1002), another bank in Tokyo quoted it as (1.1000). Now, these institutional investors immediately get to know the price difference before the normal investor or trader buys from Tokyo and sells it in London to pocket tiny profits per trade, amounting to a significant amount after compounding the profits of many such trades. However, Abby remains unaware and fails to react to the price difference and take any benefit from it.

Example #2

An article published on 19 October 2023 highlights the increasing significance of low-latency connectivity for facilitating crypto trading by institutional investors. The possibility comes after the Biden administration passed its first executive order concerning crypto trading regulations, which increases the chances of the involvement of institutional investors. Additionally, the set-up of crypto hubs in Singapore with clear regulations underscores the pressing need for international connectivity for crypto trading.

Since it involves latency-sensitive activities such as arbitrage trading, more reliable solutions are needed. Hence, to attract trading firms, one can install cloud-cloud connections with dedicated networks to give predictable low latency. Further, some exchanges have even offered physical infrastructure to attract institutional investors and adhere to possible regulations mandating private market reach.

How To Mitigate Its Effects?

Traders can implement the below strategies to mitigate the effects of this approach:

Using trading algorithms designed to find and act on any arbitrage chances.
Invest in high-quality network infrastructure like routers and low-latency switches to reduce latency.
Place servers at co-location to decrease the physical distance between the trading system and exchange, decreasing latency significantly.
Using ultra-low latency (ULL) technologies like specialized network adapters and field-programmable gate arrays (FPGAs) further minimizes the latency and improves trading efficiency.
Regularly analyze and monitor latency to remove any blockage and inefficiencies from the trading system
Get proper education and training.
Select the brokerage firm offering the lowest latency and HFT facility for trading.
Diversify investments, set up stop-loss orders, and implement risk strategies to limit potential losses on account of latency arbitrage on one’s trading.

Advantages And Disadvantages

As with any trading strategy, this approach has its advantages and disadvantages, which are outlined in the table below:

Advantages	Disadvantages
It turns out to be a highly profitable trading strategy for HFT institutions.	It can be highly risky due to any plausible glitches or errors in the software, or speed can take out all profits from the trade.
It contributes to market efficiency as it prevents prices from deviating too much.	It has been deemed as fraudulent or unethical by some brokers due to undue advantage taken by some on account of costly infrastructure and location of the server.
This leads to the fastest fills and reduces slippage, which is the difference between the trading price and the executed price of the trading.	Adds to huge costs and expenditures on brokerage and HFT firms.
It contributes to the efficiency of markets.	This leads to market volatility as sudden high-volume trading can cause abrupt price movement that is incomprehensible to small or slower traders.