The Games Brokers Play

Unlike the stock market, the FOREX market does not have a single exchange, but rather is an electronic network (OTC) where brokers/dealers negotiate directly with one another.  Most of the key players are either central banks for sovereign countries, or leading brokerage firms dispersed throughout the globe.  There are also many smaller players in this market which comprise the Retail FOREX Market represented by Brokerage Firms of various sizes and trading capital.  Currently there are rumblings on regulating these brokerages to protect traders from the unscrupulous brokerages out there.  After all when it come to the trillions of dollars per day that are moved through this market it should be no surprise that there will be some bad players out there.

Whether regulation is mandated or not and whether you are for it or not, there are some definite things to consider when you are selecting a broker.

Before I get into that I just wanted to let you know that you can get some reviews on the web and I have found that the Forex Peace Army does a great job I providing unbiased information. They allow users to give there own reviews. As always some of the reviews are from people with beneficial interest and from those just trying to slam a different company but for the most part you can tell. The Forex Peace Army will remove biased comments when they are found out. So all in all I would do a check there.

There are many levels of pricing access to the FOREX Markets of which the highest level of access is the Inter-Bank market which is comprised mostly of investment banking firms.  This market is open only to the big players like Central Banks, Corporations, Hedge Funds or any financial institution that deals with very large currency transactions.

The Retail FOREX market developed with the rise of online trading and the availability Retail brokers. Retail brokers allow small time traders to connect to the immense market of the FOREX world; however, this market lacks the stringent regulation found at the higher levels with larger players.  This lack of regulation is the reason why some brokers can sometimes play games and employ unscrupulous practices in order to reap the greatest amount of profit from the least experienced traders.

This is where understanding and being able to spot these games is important. Please go to Authentic Advisor and rate your broker or ask to have one added to the list.

The level of accuracy in quoted pricing is the most important factor in giving the trader the best advantage at success.  Pricing can be broken out into the spread and the consistency and accuracy of the quoted bid/ask.  The spread is defined between the highest price a party is willing to pay (the bid), and the lowest price a party is willing to sell (the ask).

Using a broker that quotes a fair spread is one of the primary concerns in choosing the right broker.  Larger banks and institutions which have the highest access to pricing share the most precise quoted spread.  Traders who access the FOREX markets through the Retail Market will never have as accurate pricing as the larger players, but choosing the right broker can get you the best level of access available.

There are primarily two types of brokers you can choose; Market Makers (brokers with dealer desks) or Electronic Communications Network (ECN).  Each has its own advantages and disadvantages.

Because the inter-bank market is generally for trading between institutions with very large transactions a market maker will usually trade large blocks of currency with the inter-bank market, but then turn around and make smaller trades with the retail trader using their own internal pool of currency.

What this means is that the market maker is actually taking the opposite side of your trade. So when you place a trade you are actually trading against your broker, the market maker. Unfortunately this creates a huge conflict of interest between you and your broker because the money you lose in a trade is money the broker wins in a trade. Money you win is money your broker loses. That’s a major conflict of interest!

Most new retail FOREX traders are unaware of this and falsely believe that their broker is only making money off the spread.  One of the symptoms I discovered while trading (with a broker that I’m no longer using) was how when price was moving in my favor the spread would shift to cause the profit to disappear.  In other words my sell order was 1.3328 and the price went in my favor 3 pips 1.3325 the spread changed and my profit was negative and as the price continued in my favor the spread grew even more making the loss even higher; as the price slowly went against me the spread progressively returned so that my trade balance was always negative.  That was my first experience with an unscrupulous broker.

Here are a couple of other tactics that have been noticed.

   1. Unscrupulous brokers may manipulate pricing through spikes to trigger any stops that you have placed on your positions.

   2. Unscrupulous brokers may manipulate the spread just when you are about to make strategic trades (this is one reason why some robots use stealth technologies to hide their trading intentions)

   3. Because of the control market maker type brokers have of the price feed it is sometimes the case that unscrupulous brokers will force re-quotes as a way of avoiding a losing trade on their part.

  4. Lastly, some unscrupulous market makers have even been known to simply deny executions to your trades or even routinely disconnect your account.

The unfortunate thing about this is that you will never notice these games on a demo account, the demo account will allow you to practice without risk, however it can’t replicate what happens on a live trade. This is why even unscrupulous brokers can lure the unwary trader into opening an account.  Brokers should be tested first in demo and then cautiously moved from demo to real money accounts. Because demo price feeds can often differ significantly from real money feeds it’s important that when you do switch to a live trading account that you start out trading very small until you have a feel for the quality of your broker.

The important thing to keep in mind is that while the market maker type broker has a much greater opportunity to employ unethical tactics against you this does not meant they all will. There are ethical brokers out there who value their reputation and understand that by building their reputation they can actually win out in the long run over the shorter sighted brokers who might choose short term profits by cheating you over long term profits by keeping you as a client.

Electronic Communications Network (ECN)

Unlike market maker type brokers, ECNs offer direct access to larger banks and trading institutions that make up the inter-bank marketplace. An ECN is usually connected to a number of large banks offering price quotes for which the ECN will take the most competitive quote available and pass it on to you.

This has a number of implications that significantly differentiate it from the market maker type of broker

   1. Because ECNs are not pooling their own resources and then offering you a quote from their own trading pool, but rather offering you a near real-time competitive quote from a number of institutions, you will not have nearly as stable of price as you will with a market maker

   2. While the price and spread may fluctuate much more rapidly than with a market maker, you are generally going to find a more competitive price and spread precisely because there is competition creating the price rather than just the market maker

   3. With ECN brokers you are not trading directly against the broker. In other words, the broker is not taking the other side of your trade and therefore has no vested interest in whether you win or lose the trade, because they have no vested interest in whether you win or lose the trade there is less incentive for them to apply unethical price manipulation as discussed with market makers

   5. Some ECNs may also offer stop-limit orders that can help control slippage on your fills

 ECN brokers have been around a few years, but until recently they were hard to come by, especially with those offering metatrader platform trading.

There is one other type broker you may come across know as a Straight Through Processor. This is essentially like an ECN, but simply differs in the technology they use to give you access to the inter-bank and to process your orders. When it comes to the advantages and disadvantages listed earlier in this article the Straight Through Processor and the ECN are essentially the same.

When it comes to choosing a broker you have two choices; a market Maker (dealer desk) or and ECN / Straight Through Processor broker. There are good and bad brokers in both categories.

To summarize here is what you need to look out for.

Beware of spread manipulation!  When there are a multitude of market makers trading at the higher levels of pricing access, the trading spread can be kept very thin.  As the participants move away from top levels of pricing access (ie. retail trading), this spread can be kept wide by the key players and brokers as they generate a portion of their profits on the width of the spread.

Aside of spread manipulation, there is the issue of re-quoting. Re-quoting comes into play during order execution.  As the client of a brokerage is ready to execute a trade, their trade intention is exposed when they click on the bid or the ask to request an accurate quote.  As the broker is now aware of the client’s intent they can sometimes issue a quote that is worse than the current market.

This can also happen in the course of a normal trade for legitimate reasons when the market simply moves away from the initially quoted price, causing a re-quote.  If the market is very dynamic during the moment a trade is initiated, re-quoting can cause delays to order execution. Typically dealer desks are often more likely to use re-quoting unethically as a tool against you.

Ultimately, your broker should be able to give you an order that is very close to the price quoted when you placed the order. If this is not happening and you are getting too many re-quotes then consider changing brokers.

Also, be aware that not all brokers will accept clients from all locations and therefore you may not always have as much choice in brokers as you would like to have.