Will high-speed traders be bowled over by an Indian summer?

As the Indian Premier League (IPL) gets into full swing, Fraser Bell of BSO explains why competing teams won’t be the only ones relying on speed to underpin their strategies, as High Frequency Traders (HFT) turn their attention towards the emerging markets.

From faster execution speeds to increasingly sophisticated strategies and booming global interest – the IPL and HFT have a lot more in common than one might think. Over 335 million people tuned into last year’s Indian cricket extravaganza, while algo trading and HFT now accounts for roughly 40 per cent of all of India’s trades – the highest proportion of high-speed transactions in the developing world. And similar to previous IPL winners, the best HFT firms have a plan at the heart of their success. But exactly what’s driving this insatiable demand for HFT in emerging markets, and what trading strategies are being deployed to take advantage?

With equity trading saturated in established markets, it is easy to see why high-speed traders are exploring new asset classes across emerging regions. With new metal contracts soon to be available to trade between the LME and the Dubai Gold & Commodities Exchange, coupled with the Shanghai Futures Exchange’s plans to announce new gold contracts, there’s no shortage of opportunity. Where there is opportunity like this, it’s a safe bet that market makers will already be working on the smartest arbitrage strategies to take full advantage. For high-speed traders, these new commodities contracts could literally be worth their weight in gold. Why? Well, unlike standard cash equity markets (the traditional playground for HFTs), it is harder to define a price for futures or options contracts and there is often no consensus between exchanges on the value of the asset being traded. This is, of course, music to the ears of high-speed traders as it presents them with ideal pricing discrepancies to arbitrage between.

However, it’s not just about seeking pricing differentials. Prop shops also benefit from certain countries, such as India, deploying lighter touch regulatory regimes. Unlike policy makers across Europe and the U.S, who have cracked down on HFT through methods such as ‘speed bumps’ to try and level the playing field, Indian regulators are yet to implement such rules. While this may well change in the future, while there is light touch regulation, like a fast bowler on a bouncy wicket, high-speed traders will look to make hay while the sun shines.

That said, having clever arbitrage strategies alone is not enough. It has to be underpinned by speed, because ultimately, the trading firm that reaches the exchange first wins. While most prop shops have established low-latency connectivity links across Europe and the U.S, not all of them have access to quotes in Mumbai or Dubai from New York or London in a matter of milliseconds. After all, an HFT firm can’t profit from price discrepancies once new gold contracts get issued if a competitor has faster access to quotes.

Arbitrage without speed is much like a cricket team without a fast bowler. And as all eyes turn towards the IPL over the coming weeks, the team that perfects its strategy supported by a ruthless fast bowling attack, is likely to come out on top. For high-speed traders looking to tap into derivatives across emerging markets, it’s no different. There’s clearly opportunity in abundance, but only the ones underpinning their trading strategies with the fastest connectivity will share the spoils.