Strategies for Profiting from News Trades: Colocation
Many traders have lost money from news trades. I remember my first experience trading the Non-Farm Payrolls report back in 2006, when I lost some good money after being entered on the retracement by my broker. I look back at those early days of foolishness when I constantly went to war against an army with heavy artillery armed with just a Beretta pistol. Such naivety is what led me and many other traders to keep losing money in an arena dominated by battle-tested warriors (traders in institutional firms with 25 to 30 years experience).
Over the years, I have come to discover many secrets of news trading and I will share some of them with you. One of these secrets is the magic of colocation.
What is Colocation?
Colocation is the practice of keeping your trading equipment (computers, routers or servers) containing algorithmic trading software very close to the data centres of brokerages and news agencies through which the market-moving financial news on the economic calendar are released. Colocation is not only used by news traders, but by every trading entity that practices high speed and price sensitive trading.
Why is Colocation Important in News Trading?
For us to understand just why colocation is important, let us understand how a typical news trade plays out.
The news are released to brokers through data centres, and from there to the trading platforms of their clients. The traders whose servers are closest to the data centres receive the news before everyone else. This is simply logical. If a car takes off from Rhode Island in New York, it is more likely to get to Bayonne in New Jersey earlier than it would reach Buenos Aires, or Los Angeles, or Minsk. Watch your favourite news channel, e.g. CNN. Notice that when an anchor at the CNN centre in Atlanta is talking to a correspondent in another continent, there is a time lag (a latency period) between when the anchor asks the question and when the reporter starts to answer. Sound travels at 330m/s, light at speeds much faster, but there will always be a latency period in the order of milliseconds.
By placing the servers and algorithmic trading software close to the servers on which the data centres that release the news are located, colocation serves to narrow this time lag, or latency period. The result is that traders with colocation facilities will get the news release before every one else, and by the same colocation advantage, be able to take a position in a currency asset faster and with more precision, blocking out any chance of requotes or missing out on the initial spike.
This is why a retail trader with no knowledge of colocation will get into a news trade with high hopes, and end up being beaten out of the trade by the colocation-compliant traders. It is truly disheartening that a market can be so lopsided when it comes to information and tools for success, but then we have to remember that all fingers are not equal. It is up to the trader to decide which finger he will be a part of: the disadvantaged fourth and fifth finger, or the powerful thumb which has 50% of all finger function even though it is not the longest of them all.
How to Plugin to Colocation
This is not a cheap affair, but if you are like me who wants to grab as much as he can out of the $4 trillion that circulates in the market everyday, you have to be prepared to make the bucks by spending some of it to be prepared. Anything else will mean that your money will keep paying the profits of the colocator-compliant traders in the market.
There are distinct colocation hubs:
a) New York (this is where the US session news releases originate from).
b) London (where the London session news releases emanate from).
c) Chicago (located close to the commodity exchanges).
d) New Jersey: Located close to New York and assumed importance as a colocation centre following 9/11 and the security implications that event instigated.
Colocation services can be acquired from firms who have provided such facilities on a subscription basis. Traders can also acquire colocated forex services through specific brokers, mostly those on an ECN platform. The costs are thus passed on to the traders, who pay a charge for using these services. Examples of brokers who have existing colocation services obtained from third party providers are:
a) Gain Capital Group (Forex.com)
b) FXCM Pro
c) Integral FX
d) Knight Hotspot FX
e) Currenex (and its partner brokers)
So if you want to trade the news, do not go to battle blindfolded. Plug into co-location and see the wonders it will work for your news trades.