There has been a growing acceptance among the trading community that simply pursuing the same old strategies in the same old markets no longer works as a business model. The competitive pressure of too many participants trying to capture the same alpha opportunity has simply squeezed the P&L of that opportunity out of existence. As a result, more and more traders are finding that the markets in which they have operated for (perhaps many) years are now simply too competitive, so they are realising that an alternative business strategy is clearly needed.
This realisation is driving a major shift in focus as traders look for new opportunities. Apart from investigating new markets and asset classes in their own right, they are also looking at different combinations of these in order to develop cross-border arbitrage strategies. At the same time, there is growing interest in diversification of strategy, so traders that previously might have focused on low-latency and high-frequency as part of a market making strategy are now investigating more complex quantitative or technical approaches.
On the geographical front, Asia - and especially China - is high on the shopping list of many traders in the US and Europe. Interestingly, the opposite is also true: RTS already has a significant number of clients trading in China, but it also has most of the largest Chinese brokers as clients, who are servicing their own clients.
As regards asset classes, there is similar diversification. There is growing interest among traders who might previously only have traded stocks or futures in trading foreign exchange as an asset class in its own right. While some of this new demand is in the spot market, there is also increasing activity in non deliverable forwards provided by leading investment banks. Physical commodities are also becoming a popular trading vehicle, but not just exchange listed products. Exchange look alike commodity contracts, also provided by leading investment banks, are enjoying rising popularity. These in turn raise interesting new arbitrage opportunities against the exchange listed contracts that some of them are intended to replicate.
Apart from its popularity as an asset class in its own right, foreign exchange is inevitably growing in importance in an environment where cross border trading is on the rise. Anyone arbitraging between COMEX gold and TOCOM gold is also implicitly trading between USD and JPY. The same implied foreign exchange trades apply for those arbitraging between Singapore and Osaka stock indices, or even between EUROSTOXX and the S&P - in
every cross border trade there is a currency pair involved and the risk of that needs to be managed in the foreign exchange markets.
In conjunction with trading foreign exchange as an asset class, this sort of hedging activity is inevitably driving greater demand, but not just in the major pairs. A combination of mature and emerging market traders and their desire to explore new and remote markets is also driving greater need for liquidity beyond mainstream pairs.
Time to market, costs and functionality
The changing competitive landscape and the consequent need to access new markets and instruments inevitably have major implications for traders in terms of technology, market access and clearing/brokerage relationships. One important point is that the pressures that have squeezed alpha in domestic markets and existing trading strategies can squeeze it again in new markets and strategies. Therefore there is a need to minimise implementation latency and get new trading connections and infrastructure up and running as soon as possible.
This isn't easy under the traditional approach of using in-house hardware and connectivity. Rack space in suitable colocation facilities has to be sourced and leased, which isn't trivial when it has to be done from several thousand miles away in a different time zone. Similarly, lines and circuits have to be scoped, ordered and provisioned. Then there are the brokerage and clearing arrangements to consider. Do existing relationships have a presence in the intended new markets? No? In which case there is a raft of due diligence on possible new brokers and clearers to deal with, plus the administrative admin of opening new accounts with unfamiliar firms. As a result, there's the very real risk that the firm's new multi-market or multi-asset trading initiative (or even just single remote-market trading initiative) will quickly become bogged down in procurement and paperwork and thus be overtaken by fleeter-footed competitors.
Then there are the costs to consider. Colocation rack space and connectivity for just one new remote market is expensive enough, but if the trading firm needs to access multi-legged arbitrage opportunities then the costs will scale up accordingly.
Finally, there's the need for strategic flexibility. A trading firm's existing technology may be fine for low latency market making strategies, but what if there are limitations on deploying those same strategies in new markets, or if the firm needs the flexibility to be able to diversify into other more quantitative or technical types of strategy? Can it realistically build all the necessary strategy development tools and other functionality in house and then deploy them all in a reasonable time frame?
New world, new paradigm
Realistically, the new global trading environment as outlined above requires a completely new approach. Traditional methods of building and/or owning the bulk of the necessary technology and infrastructure make little sense when there is a need to be nimble, manage costs and maintain trading strategy flexibility.
In this new world, the ideal is to have a service provider that can deliver a global trading network (see Figure 1) out of the box, together with all the appropriate supporting components. This means that such a provider can supply maximum global exchange coverage (for instance, RTS is connected to 135 exchanges) but can also access global brokerage relationships in order to facilitate introductions and minimise connectivity times.
However, this alone is insufficient. The costs and inconvenience of owning, installing and managing hardware remotely makes it equally essential that a service provider can also offer cost-effective and immediate colocation and connectivity for all the markets it supports. If so, technology implementation times can be compressed from weeks to perhaps hours, along with a commensurate reduction in hardware costs.
The final critical component is the range of strategy building tools that a service provider can offer. As mentioned earlier, a growing number of trading firms are realising that being just a one trick pony doesn't work in a rapidly changing trading landscape where competitive pressures are intense. They are therefore looking for a combination of tools that will cover everything from low latency scalping to quantitative or technical trading strategies - plus the ability to back test and simulate those strategies accurately. For instance, in addition to its RTD Tango ultra-low latency product, RTS also offers Tango QUANT. Furthermore, Tango QUANT is now available pre-configured with connectivity to Interactive Brokers, which can cut access times to global markets to less than a day, as well as providing access to Interactive Brokers' simulated market environment for realistic strategy testing.
At first glance, the new global trading environment appears extremely daunting. One the one hand, ever-increasing competitive pressure is driving the need for geographic, asset type and strategy diversification. On the other, there are the high costs and delays of responding to that pressure by deploying in house technology and resources in remote and unfamiliar markets.
The ideal solution is to be working with a provider that can deliver a turnkey on-demand solution to the myriad requirements and diversification now required for competitive trading: access to multiple countries, exchanges, broker/clearer relationships and asset types (including those traded off-exchange), plus the necessary development and execution tools to enable strategy diversification.
The snag is that most providers struggle to fulfil more than just one of these requirements. Some may have the necessary exchange connectivity, but lack an adequate colocation offering, while others may have adequate broker relationships but have model development technology that can only support one type of trading strategy.
The bottom line is that the number of providers that can cover all these essential bases is extremely small. In fact you might even say that it is a number tending towards one...