Latency Arbitrage has increasingly become a hot button issue for Forex Brokers. New Forex Broker entrants to the market routinely get “picked off” (exploited) if they don’t have the correct technology in place and configured. What is latency arbitrage abuse? Well essentially, it’s when a trader uses an automated trading system to look at multiple price feeds and make risk free trades on the system with the delayed prices based on where they know prices will be in the future by looking at the faster price feed. The video below explains it very well.
So as a Forex Broker, how do you defend yourself against what can be described as gaming the system? The best solution is to have trading platform technology in place that automatically prevents or defends against this type of behavior. Using timed execution delays is the most popular setting as it negates the benefit of the trader knowing where the market will be milliseconds ahead of time. Adding random small amounts of slippage into a percentage of all trades can also be an effective method of stopping latency arbitrage, but the problem with this method is that normal traders may complain. The best solution is to have an automated segregation tool in place that can define “latency arbitrage” traders based on pre-set criteria and move them into a different group that has settings to give increased execution delays and slippage. Using this method, you essentially prevent traders from performing latency arbitrage to make money, while at the same time not having normal traders complain.
Regardless of how you decide to deal with potential latency arbitrage abuse, it’s a good idea to write a clause into your Forex Broker’s terms and conditions that clients have to agree to before they start trading with your broker. Here’s an example:
“ARBITRAGE: Internet, connectivity delays, and price feed errors sometimes create a situation where the price displayed on the BROKERs online facility do not accurately reflect the market rates.
BROKER does not permit the practice of latency arbitrage on the BROKERs trading platform. Transactions based on latency arbitrage may be revoked without any prior notice. BROKER reserves the right to make any necessary adjustments or corrections on accounts involved without any prior notice. You agree that any dispute arising from such execution or quoting errors will be resolved by BROKER in their sole and absolute discretion. BROKER shall have no obligation to contact you about occurrences of trades suspected to involve latency arbitrage and any subsequent corrections. You agree to indemnify and hold BROKER, it’s directors, employees, and agents harmless from and against any and all liabilities, losses, damages, costs, and expenses.”