How the Forex Broker Industry really works

Situation

The early days of the Retail Online Trading Industry are, or more accurately should be, a thing of the past. Why? Because the latest Business and Technology transformations have eventually made the impossible possible.

With daily volumes estimated at USD 300+ Billion, Retail Forex (i.e. your trades) already accounts for 8% of the global Forex Market. It has proven one of the fastest growing and is nowadays one of the most sought after segments of the Forex Industry. 

Tier1 Bank and non-Bank (i.e. Hedge Funds, Dark Pools, etc.) Liquidity Pools are now actively seeking Retail Liquidity, hence started to open-up a once restricted direct access to the inter-banking Market. 

In other words, all combined, your retail trades are worth Billions, probably as much as those of any given major Financial Institution, and what used to be a No-Business has now became The Business, full stop. 

Robust bridging, aggregation and clearing technology have finally emerged to fill the gap between the inter-banking Market and popular Retail Trading platforms, such as the Meta Trader, which were historically strictly designed to operate under Market Making conditions (i.e. lacking sufficient technology to provide direct access the inter-banking Market).

As a natural evolution, Retail Traders may now benefit from a direct access to the inter-banking Forex Market under the same conditions as any given Financial Institution, while keeping their marks using their preferred Retail Trading platforms, including the Meta Trader.

In 2014, Agency Model only (i.e. 100% DMA/STP Execution), transparent pricing (i.e. no spread mark-up), MiFID compliant post-trade transparency (i.e. who filled your trade / when / how fast / at what price) and full anonymity (i.e. anonymous Stop Losses and Take Profits to the counterparty) shall be the only standard for Meta Trader users and more so their only concerns, certainly not Bonuses and other Cash Promotions.

Unfortunately it is not.

Complications

Numerous so called “world class” historical Retail Brokers (i.e. Alpari, FXCM, FXDD, FX Sol, and more) are still resilient to embrace the change.

Not only do they actively prevent access to all the above by raising their thresholds on “Pro” accounts and/or by adding intentional complexity to their offering (i.e. too many account types, terms and conditions, pricing and execution structures, etc.), but they also tend to attract Retail clients by spending millions of Dollars on numerous cash promotions (i.e. Credit Bonuses) and advertising campaigns in order to distract their clients’ attention from what truly matters:

• How pertinent is the order I want to execute? (the Trader’s side)
• How accurately, how fast and by whom will my order be executed? (the Broker’s side)

Why add more complexity by selecting the wrong Broker when Margin Trading itself is one of the riskiest forms of investments? Leverage can work against traders as well as for traders, and losses can exceed one’s entire investment. That is more than enough to cope with, and everything else shall strictly lead towards Retail Traders’ interests in order to facilitate chances of success, without any compromises.

The world’s best and most advanced technology would be worth nothing if it wasn’t for the applications leveraging from it. How good can any innovation such as Social Trading platforms be if in the end your trades are to be executed by a Market Maker which will have total control over your trades’ pricing and execution?

Any Broker claiming an STP / NDD / DMA / ECN / PRO offering, may nevertheless “Make the Market” even if partially (i.e. STP 50% of clients’ orders and make the market on the other 50%). In theory, there is nothing wrong with this configuration as long as the Broker runs an ethical business. In practice, Regulators such as the NFA and the FCA have both demonstrated condemnable practices conducted against Retail Clients’ interests by "world-class" historical Retail Brokers claiming out and loud such STP/NDD operations. The temptations to manipulate pricing and execution to the sole interest of the broker’s bottom line remain systematic.

Indeed, what truly needs to evolve is the constant conflict of interests sitting behind any of the latest innovations. Social Trading Networks, Automated Trading Platforms, or ECN/Pro Account types, as good as they can be must now leverage from the latest business models to make a significant difference. Otherwise they will only act as another nail polish hiding the not-so-bright truth driving the Retail Trading Industry (i.e. preventing Retail Traders from a direct access to the Markets).

Are Retail Market Making Brokers and Tier1 Banks both Market Makers?
Simply put, "yes but". As much as a Retail Market Making Broker, any Tier1 Bank will also operate as a Market Maker, hence have total control over pricing and execution, yet with significant variations.

Firstly, in both cases your profits are indeed the Market Maker’s losses, except that Retail Liquidity (i.e. your trades) only represents a fraction of any Tier1 Liquidity Provider’s business, whereas it unfortunately represents the vast majority of any Retail Broker’s business, hence the vast majority of its Profits & Losses.

Additionally, Tier1 Liquidity Providers usually transform Retail Liquidity into Added-Value inter-banking Liquidity. Whenever the Market suffers from shortage of Liquidity (i.e. not enough Liquidity available on the Market), Tier1 Liquidity Providers tend to source additional Liquidity from the rapidly growing Retail Market (i.e. your trades) in order to resell it at a better price to other Tier1 Liquidity Providers, thus realising a profit.

In the theoretical and very unlikely event where every single Retail Trader would realize a profit at the exact same time and if all Retail trades were straight through processed to Tier1 Liquidity Providers (which is hardly the case nowadays as the vast majority of Retail Brokers are Making the Market, hence preventing Tier1 Liquidity Providers to access Retail Liquidity), these would indeed suffer an aggregated loss of USD 300+ Billions. 300+ Billions would certainly appear as a significant amount if taken out of context, yet it only would represent 8% of the total daily global Forex Market volume which may not be sufficient to bankrupt the Market players as a whole.

The same example applied at the Retail Brokerage level would have other consequences. Any Retail Market Maker (i.e. the vast majority of Retail Brokers) may then suffer from dramatic losses, possibly leading to bankruptcy.

Secondly, trading under a 100% DMA/STP Agency Model grants Retail Traders with full anonymity on the inter-banking Market.  Stop Losses and Take Profits limits are kept within their Retail Broker books, out of reach from Tier1 Liquidity Providers, hence preventing any potential price and execution manipulations at the inter-banking level, such as Stop Hunting or Requoting. 

As long as Retail Brokers will purposely lock their clients into precarious terms, Retail Traders will inevitably suffer from the full exposition of their trading strategies, including Brokers’ visibility on their Stop Outs and Take Profits, coupled with a systematic conflict of interest (i.e. client profits are their Brokers’ losses).
Simply put, trading with a Retail Market Maker equates to kneel down at its mercy.

Inevitably, over the most recent years and despite all the latest business and technology improvements, questionable practices conducted by numerous so called “world class” historical regulated brokers have been exposed by renowned financial regulators such as the NFA and the FCA. Such cases have been fully referenced online and we at JFD Brokers invite Retail Traders to run their own research accordingly. Most cases present unfair and unethical business practices, often preventing Retail Traders from realizing profits, or worse forcing their losses. 

The question remains, why and how such Retail Market Making Brokers are still attracting Traders?
We see 2 main reasons for this:

1. Until most recently there were no valuable alternatives.
2. Such alternatives are yet to be known from the Retail audience.

As concerning, nowadays new Online Retail Brokerages are being established throughout the world every other week.  In effect, establishing a new Brokerage is as easy as 1, 2, 3.

1. raise some funds, a few thousands may suffice.
2. setup a white Label partnership with a Tier2 or Tier3 unscrupulous Retail Market Maker.
3. build a flashy website and kick-off Marketing and Promotional campaigns online promising great returns and attractive welcome bonuses.

From the most newly established to the largest “world-class” historical kind, nowadays most Retail Brokers claim for Transparency, Fairness, STP, ECN, NDD and a number of other attractive attributes.

It is about time for the Retail Trading Community to challenge such Brokers with the following set of questions:

• Are you fully authorised and regulated by a well regarded Financial Regulator such as NFA, FCA, CySEC, ASIC, BaFin etc.?
•  If so, does your License grant you permission for “Dealing on Own Account” (i.e. permission to “Make the Market”)?
• Most importantly, will you systematically provide upon my request a MiFID Compliant Post-Trade Transparency Execution Report presenting which Tier1 Liquidity Provider filled my trades? 

If any of the above is answered negatively, chances are your Broker does purposely maintain a (most lucrative) conflict of interests with its clients and, as described previously, may not systematically be in business to protect your sole interests.

Solution