High-frequency trading strategy: Triangle leverage

High-frequency trading strategy: Triangle leverage

In the meantime, I'm going to try to get some ideas out of the foreign exchange market as an example.

Of all high-frequency trading, foreign exchange swaps and short-term foreign exchange account for the largest share. The high liquidity and low processing fees of foreign exchange provide the possibility for high exchange rates and very short holdings. As one of the most primitive strategies for high-frequency foreign exchange, triangular arbitrage must be mentioned. Here I share with you my understanding of triangular arbitrage in high-frequency trading in the foreign exchange market.

The so-called triangular leverage is a leverage method that introduces three currencies. It leverages the temporary deviation of the three currencies from a reasonable cross exchange rate to achieve leverage. Theoretically, if we have a low latency bidding platform and can obtain a lower bid/ask spread, then we have the opportunity to achieve risk-free leverage.

• A simple example.

  Let's start with a simple example: For ease of understanding, we are not considering bid-ask spreads and bid-failures here.

  • 1. Yens 118/$
  • 2. $1.81/pound
  • 3. Yens 204/pound Here the yen is the yen, the dollar is the dollar, and the pound is the pound.

  The answer is yes. Here are our steps:

  • 1. Watch the actual cross rate of the JPY/GBP: 204/yen/pound
  • 2. Calculate the JPY/GBP synthetic cross rate = 1.81 * 118 = Yen 213.58/pound.

  We found that the actual cross exchange rate is not the same as the synthetic cross exchange rate, and leverage opportunities exist.

  • 3. Let's say we have 204 days, and we do the following three steps:
    • Converting the 204th circle to 1 pound
    • Converting 1 pound to $1.81
    • $1.81 to 213.38 yen
  • 4. We got a risk-free return of 213.38 - 204 = 9.38 yen.

• Let's take a look back at one of the core concepts:

  Synthetic cross rate and its price deviation Since most currency pairs are based on the US dollar (e.g. GBP/USD, EUR/USD), we refer to currency pairs that are not based on the US dollar as cross currency pairs (e.g. GBP/EUR, GBP/EUR). However, due to low liquidity and market shocks, many institutional investors are unable to directly buy large amounts of cross currency pairs, so they use a synthetic approach: GBP/EUR is equal to GBP/USD * USD/EUR

  Because GBP/USD and USD/EUR have a high degree of liquidity, they are easily positioned against GBP/EUR using this composite formula. Because of the high liquidity of the forex market, the market is effective most of the time, so the composite price should be equal to the market price. However, the market is sometimes in a short-term imbalance, causing the market price and the composite price of the cross currency pair to deviate. When this deviation is sufficient to offset our trading costs, we can use the triangle arbitrage method to achieve risk-free profits.

• The Triangle's leverage strategy

  This strategy uses the market price difference between the cross-currency pair and its synthetic price to achieve arbitrage.

  1. 我们关注三个外汇对：EUR/USD,GBP/USD,以及GBP/EUR.
  2. Calculate the combined bid and ask price of GBP/EUR: GBP/EUR (synthetic, bid) = GBP/USD (market, bid) * USD/EUR (market, bid) is the price at which the price of a currency is determined. GBP/EUR (synthetic, ask) = GBP/USD (market, ask) * USD/EUR (market, ask) is the currency of the United States.
  3. If at this point the GBP/EUR compound bid is greater than its market ask price, we take the strategy of buying into the market GBP/EUR and selling the compound at the same time. Here, we only hold the stock for a short time until the GBP/EUR compound breaks even at the market price. Since the spread expense has always existed, we should ensure that the compound price is sufficiently large to cover the spread of GBP/USD and USD/EUR, while ensuring that all three sets of exchange rates are sampled simultaneously.

• The ending

  In practical operation, this strategy has strict requirements for the equipment and speed of trading. With the electronization and automation of trading, it is almost impossible for price differentials in the markets to exist for a long time, so price deviations will only exist for a very short period of time. This therefore requires traders to be able to obtain very low delays and trading fees. Otherwise, triangular leverage can only remain at the theoretical level.

  Translated from WeChat by Foreign Exchange Gold Little Helper