It is often said that success is 1% inspiration and 99% perspiration.  The business of High Frequency Trading (HFT) in the global forex markets fits that adage.  In many cases, HFT also referred to as algorithmic trading, aims to earn small, short-term profits on a high number of trades.  One must devise a trading strategy and develop and maintain a complex, algorithmic system to constantly look for profitable opportunities.  Institutional Forex trading has only recently embraced HFT in the past 5-6 years.

In order to execute a prescribed strategy in a systematic manner, the principal trading entity (the trader) must first conceive and deliver a viable trading strategy that is then rendered as a machine-readable algorithm.  Once back-tested and benchmarked for statistical probability of success, a principal must engage the requisite liquidity source or sources, establish credit arrangements with counterparties, procure the hardware to house the execution and risk-management environment and optimize the technical infrastructure such as software and operating systems.

Institutional level HFT is rarely conducted over the public internet, due to latency issues and is generally outsourced to an institutional-grade data center.  Due to the extreme necessity for speed in the execution of trades, most principals seek to co-locate their transaction servers at distances measured within meters of their liquidity provider's servers.  Milliseconds can mean the difference between success and failure in High Frequency Trading.

Seeking Alpha within Low-Cost Transaction Environments

The global spot currency market is ideally suited for High Frequency Trading because of the low transaction costs associated with the asset class and the deep liquidity offered in the global forex markets, which are estimated to be approximately $5 trillion per day according to the Bank for International Settlements (BIS).  Over-the-counter spot forex trading does not carry the costs-such as ticket fees-- usually associated with exchange-traded instruments as in the futures and securities markets.  The principal trader incurs transaction costs through the bid/ask spread, and it becomes imperative to seek the lowest possible spreads available.  Generally speaking, there is direct correlation between spread size, trade size and monthly-transacted volumes.  The greater the deal size and monthly volume, the lower or narrower the spreads are likely to be. 

Ideally, the principal should seek a liquidity provider that offers the lowest institutional spreads, or near what is referred to as choice.  A choice spread offers dealing at the same rate for bid and ask (no spread).  In most cases choice spreads carry a fee based on volume transacted.  Fee-based models can be as much as $20 per million dollars transacted but are in most cases negotiable.   One of the benefits of a choice spread for the principal trader is a fixed cost structure.  That is of course assuming the spread is consistently lower...or similar to that of non-fee-based arrangements.

 In almost all arrangements, spreads are not fixed and will vary based on market conditions.  It is therefore necessary to manually monitor your liquidity price feed over an extended period to observe fluctuations, anomalies or other non-standard biases in price behavior.  Fee-based arrangements will often require the trader to maintain a small balance in a cash account for the weekly payment of transaction fees.

Fee-based arrangements have additional benefits in many cases as they also cover the cost of credit.  Seek to find a liquidity provider that can provide multiple services under one fee umbrella; this is usually the most cost-effective solution.  There are several firms who offer multiple services.  One such firm is New York-based IBTRADE

On the credit side, the counterparty or liquidity provider chosen by the trader should be able to provide credit directly or through a prime-brokerage account or other credit and swap agreements such as give-ups.  Naturally, due diligence should be exercised and credit worthiness should be vetted through the appropriate channels.

Single-Source, Fully Disclosed Bank Feed vs. Anonymous, Multibank Feed

The trader should seek to access multiple liquidity sources to take advantage of any forex arbitrage opportunities and to ensure the deepest and most consistent pool of liquidity is available.  Trading via a single liquidity source exposes the trader to possible lapses in liquidity and adaptive biases by the liquidity provider, whereby the single source provider has full transparency into the trader's activity and may occasionally or frequently adjust spreads in a subjective manner.

The trader could integrate multiple bank or other liquidity providers and diversify their liquidity pool.  This is a complex, time-consuming and expensive proposition.  Companies such as IBTRADE offer a consolidated liquidity solution for a price and execution feed from 10 of the world's largest banks and liquidity providers as a fully integrated, multi-bank feed with complete trading anonymity.