Latency is the delay between a signal and a response. It is measured in units of time in seconds, milliseconds, microseconds, nanoseconds and so forth. Latency is an essential feature of any non-trivial mechanical or electronic system e.g. an automated trading system.

A standard way to measure latency is by determining the time it takes a given data packet to travel from source to destination and back, the round-trip time (RTT).

The data packet in the automated trading system is the message. A message is a standardized packet of data that enables a trader and an automated trading venue to communicate with each other. It is a primitive unit of valuable info that enables all the pre-trading, trading and post-trading activities. Messaging is the only way to affect the price formation process. Each message is time-stamped when it passes through a specific subsystem of an automated trading system.

Types of Latency

Here are the primary types of latency encountered in automated trading:

Communication latency

Communication latency is the delay introduced during the transmission of data between different components of a trading system. This can be reduced by buying co-location services. It encompasses the time it takes for data to travel from the trader's system to various destinations, such as the exchange's servers, liquidity providers, or other trading platforms.

• Reducing Communication Latency: Traders often seek to minimize communication latency by leveraging co-location services. Co-location involves placing their trading servers physically close to the exchange's servers.

Market-Feed Latency

Market-feed latency refers to the delay in receiving market data updates from the exchange. This includes information about prices, trade executions, order book updates, and other critical market information.

• Reducing Market-Feed Latency: To mitigate market-feed latency, traders often opt for proprietary data feeds provided by the exchange or a few data vendors. These proprietary feeds are optimized for speed and can provide market information faster than publicly available feeds for retail traders.

Trading Platform Latency

Trading platform latency encompasses the delay introduced within the trading platform itself. This latency is largely beyond the control of individual traders and is determined by the design and infrastructure of the trading platform they are using.

• Trading Platform as a Given: Traders must accept trading platform latency as a given factor that is inherent to the platform they choose to use. While they can optimize their strategies and use low-latency communication channels, they may not have direct control over the latency introduced by the platform itself.

Latency moves volatility moves.

Matching engine processing time

One of the critical aspects of automated trading is the speed at which orders are matched and executed within a trading platform's matching engine. The matching engine is the heart of an exchange or trading platform. Traders seek platforms with low-latency matching engines to ensure that their orders are executed swiftly.

Best Bid and Offer (BBO) Messages

Messages that result in changes in the Best Bid and Offer (BBO) are of utmost importance in terms of the price formation process. The BBO represents the highest bid price and the lowest ask price in the order book. It takes more time for a platform to process BBO messages than a message that changes the lengths of existing queues.

Depth Messages

Conversely, messages that add depth to the order book by introducing small orders or trading volume without changing the BBO have a less immediate impact on price formation. It doesn't move the mid-point price and takes less time to update the existing queues.

In conclusion, latency is a fundamental consideration in automated trading systems and the role of matching engine processing time and the different message types is essential for traders operating in automated trading environments. Communication latency and market-feed latency can often be managed by selecting the right services and infrastructure, while trading platform latency is a factor that traders must consider when choosing their trading platform.