Hedge Arbitrage trading- – AN ULTIMATE GUIDE FOR 2022 Monday November 8th, 2021 – Posted in: Arbitrage Software
Hedge Arbitrage Trading vs Lock Arbitrage Trading – what is the difference?
I wanted to note that many clients that message us, often confuse hedge arbitrage and lock arbitrage. In hedge arbitrage, two or many accounts are used, just like in DAAS or a multi-leg strategy, between which there is a comparison of quotes. We will try to simplify this. Let’s take account A and account B, If we see that on account A, for EURUSD, there is a quote that is higher than for EURUSD on account B, we will sell on account A and buy on account B, fixate this difference, and then wait for the opposite direction of market movements. When the price is higher on account B, we sell, and hence take the profit, capitalizing on the differences in the quotes. In hedge arbitrage, as you can tell, fast quotes from a third broker are not used. However in lock arbitrage, we do not compare accounts A and B, we compare both accounts with a provider of fast quotes. Usually, regardless of what algorithm is used, lock cl, lock cl2, or lock cl3. A lock, which is opposite orders owned on two different accounts, can be opened beforehand, or during the first arbitrage situation. The point of this is that you are comparing your accounts with a source of fast quotes, and in this way, you can use two or more accounts solely to lock. This is done so the orders are up for a longer amount of time. So basically lock arbitrage is a variation of latency arbitrage with the possibility of locking orders with another account or even with the same account.
Hedge Arbitrage Software Explanation
Now, let’s return to our hedge arbitrage, that we understand what it is. Both brokers need to have different quotes, but not a different latency. So what does this mean? For example, you have account A and B and both accounts are connected to one liquidity source, such as a bank or a quote provider which connects multiple banks, but this is the same source of quotes, but account a is opened on a broker which is located in New York, and account B is located on a broker in Australia. If the source of quotes is located in New York, the quote will arrive faster to account in New York, than account b. There will be a difference in quotes, we will open a position and then close it. but this position is because of a delay which is caused by the distance between the source of quotes and the brokers. If the broker has plugins that seek latency arbitrage, the broker can also seek hedge arbitrage.
Hedge Arbitrage EA orders – Latency or Liquidity difference?
The difference may not only be caused by the internet and the delay but could be technical such as the differences between bridges. One bridge can be faster and the other one slower. A Bridge is a program add-on that connects a server, an mt4 or mt5, with a provider of quotes. The bridge can also be located in London, or Cyprus, and so on. In this way, hedge arbitrage can work like latency arbitrage which is not exactly good.
So in order to get a pure hedge arbitrage, you need to find two brokers who have different liquidity providers. Not only that, it is required that both brokers need to be in the same data center, in this way we can eliminate the possibility that brokers are separated for distance which may be noticeable to the broker. We will get two brokers with different liquidity providers and will trade based on differences in quotes due to the liquidity providers having different connections to different banks and financial institutions. In order to eliminate the differences due to latency, in our programs we use max difference. In order to open an order, we use min difference, so the distance to open and distance to close. After a tick passes, and we compare it with a tick on another broker, and we see that there is a difference and this difference is larger than a certain value, then we open an order. This is so we can cover spreads, commission, and so on.
If the difference is smaller than the spread and commission we won’t get any benefits from opening an order. However, if it is bigger then we will open order and lock in the profit. That’s why max difference to open and max difference to close are parameters used in the programs. When these differences are too large, this is likely due to latency, or a difference in equipment. Many of our clients use two brokers in hedge arbitrage, a fast and a slow broker. This strategy also works and is profitable, but in this case, most of our orders are based on the delays of internet and equipment, however the method I believe is the best is trading based on differences in quotes. In order to further decrease the frequency of latency orders and make a less toxic stream of orders, we recommend mixing orders from other strategies in your trading, Ones that are not based on latency, or a delay system. These orders can be from expert advisors which you own, or orders from signal providers which you can find on the internet and copy onto orders with a copier, this can be manual orders, and so on. In this case, increasing the number of non-toxic orders, plus orders which are based on arbitrage which isn’t latency, will help mask the fact that some orders were opened due to a difference in quotes. The percent of these orders will be small and working with these two brokers will last longer and have a more positive effect. It is also best to create multi-leg arbitrage. For example, we have Broker A, Broker B, and Broker C. Now we can compare Broker A with Broker C and Broker B with Broker C, in this case, orders will open in different combinations in different directions, and this will camouflage any arbitrage trading. The number of orders will increase, and profit will increase. These three brokers need to be using three different liquidity providers, as before.
Which brokers are suitable for Hedge arbitrage Trading?
Hedge arbitrage achieves great results when comparing FIX API brokers, you can have for example an mt4 or mt5 broker amongst your brokers, but if you have some FIX API brokers as well, you will achieve better results, and why is this? When trading with FIX API you can use limit FOK and limit IOC, you can control slippage. If the slippage is higher than you have set, the order automatically does not get sent in. by trying some orders with multiple brokers you will be able to see which of the brokers are rejecting orders more often, and our program gives you the ability to open orders on the side that rejects orders more frequently, and if an order opens on this broker, then we will open order on the broker which less frequently rejects orders. This is the way to make sure that the order opens on both brokers, and this is the program’s way of helping you control your losses when opening. Many FIX API brokers allow you to connect to liquidity providers, and choose your liquidity. Oftentimes, you will be asked what strategy you will be using, and you cannot tell them that you are using arbitrage, as in many cases the broker will say that they will connect you to a liquidity provider that allows arbitrage. Usually, such liquidity providers, are providers which will use different instruments which will delay the feed and see where the market is moving. If your order is with the market, many liquidity providers will add slippage, and if your order is against the market they will let it go through. You should just tell the broker that you are using a grid strategy, or that you will hedge, but not using an arbitrage situation. Basically, any strategy, other than arbitrage, is okay, but do not tell the broker that you are using arbitrage as this will be a red flag for any broker. After the broker connects with you and you create an account on a FIX API broker, a conformance test is performed. This checks if the program that you are using is working fine on the broker, and so on. However this also checks which strategy you are using, and we recommend our clients to say that they are using the FIX API Trader program, which has already completed the conformance test on many technology providers. Ideally, having the FIX API Trader, you complete this test on your own without saying that you are using our FIX API Trader because many brokers already connect our company with arbitrage trading, and you may be watched more closely than before. If you cant do this on your own and you require the broker’s help, you should tell the broker you aren’t using an arbitrage strategy but something else. If you are using MT4 or MT5 for hedge arbitrage then if you compare MT4 with MT5, the chance of arbitrage trading will be lower as these brokers are fairly slow, and the difference in quotes will be smoothed out since these brokers will be slower. It is best to use them in connection with FIX API brokers and in this case, you will see that there are some differences in quotes. For this reason, we say that hedge arbitrage is recommended for traders who have a higher capital to start with, but lock arbitrage can be used with a small capital, so you should use lock arbitrage if this is the case. We can recommend this strategy to you.
Hopefully, we were able to clear up some doubts regarding your questions and please comment on which issues you would like to be reviewed next.
Author: Boris Fesenko Last Updated: 05 November 2021
Boris Fesenko is a BJF Trading Group Inc. ON, Canada https://bjftradinggroup.com owner and professional trader. His fields of expertise include forex, indices, bonds, and cryptocurrency trading and programming. He holds a Masters degree in electrical engineering and a Masters degree in programming with 21 years of experience as a Forex software developer