Broker potentialy breakdown
- FOREX - Trends, Forecasts and Implications (Episode 17: July 2012)
- HolyGrail with Martingale Systems
- Expert advisor
Dear all
Before the internet, very few individuals traded foreign exchange as they could not get access to a level of pricing that would allow them a reasonable chance to profit after transaction costs. Shortly after the internet became mainstream however several firms built online trading platforms which gave the individual trader a much higher level access to the market. The internet introduced two main features into the equation which were not present before:
1. Streaming Quotes: The Internet allowed these firms to stream quotes directly to traders and then have them execute on those quotes from their computer instead of having to deal over the phone. This automated trade processing, and therefore made it easier for firms to offer the ability to trade fx to the individuals and still be profitable.
2. Automatic Margin Calls: What is not so obvious but what was perhaps even more key is that the internet allowed an automated margin call feature to be built into the platform. This allowed firms to accept cash deposits from clients instead of having to put them through the process of signing up to trade via a credit line. As we discussed in our last lesson it is very difficult to get a credit line to trade FX and for those who do it is a lot of paperwork and hoops to jump through before they can begin trading. This would have made it impossible to offer FX trading to smaller individual traders as the cost involved in getting them set up to trade would not be worth it.
As the electronic platform allowed clients to deposit funds and then automatically cut them out of positions if they got to low on funds, this negated the need for credit lines and made the work to get an individual account open well worth it to the forex broker from a profit standpoint.
If you don't understand all the ins and outs of margin at this point don't worry as this is something that we are going to go into much more detail on in a later lesson.
For now it is simply important to understand that what these firms did was take all the traders who were not big enough by themselves to get access to good pricing and routed their order flow through one entity that was. This allowed these firms access to much tighter pricing than would otherwise have been possible which was then passed along plus a little for the brokers to the end client.
So now you can see why although the forex market has been around for a relatively long period of time, individuals have only started to trade the market over the last few years.
Anther key thing that it is important to understand here is that the
larger a firm gets in terms of trading volume, the greater access that
firm has to tighter prices and liquidity and the more likely that firm
is to be able to pass on better pricing and execution to their clients.
This video provides an introduction to electronic communications networks (ECNs), systems that allow buyers and sellers of stocks to trade directly without an intermediary.
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Most forex traders
participate in the forex market with forex brokers. There are mainly two
types of forex brokers: market makers and electronic communications
networks (ECNs). In this article we want to introduce the latter type of
brokers, the ecn forex broker.
What is an ECN forex broker?
ECN forex broker is a financial expert that provides the clients with
direct access to other forex participants in the currency market by
using electronic communications networks (ECNs). Unlike market makers,
which always trade against their clients to make profit, an ECN forex
broker only creates opportunities of trading between forex traders.
How does an ECN forex broker work?
The ECN
forex brokers provide a medium by passing on the prices for different
market participants such as banks, market makers and other traders in
the market. Then the best bid/ask quotes will be displayed on the
trading platforms based on these prices. ECN forex brokers also serve as
counterparties to forex transactions, but it is a settlement that they
operate on instead of pricing basis. While fixed spreads are offered by
some market makers, spreads of currency pairs can be very different,
determined by the trading activities of the currency pair. In active
trading periods, sometimes you cannot get ECN spread at all, especially
in those very liquid currency pairs such as the majors (EUR/USD,
GBP/USD, USD/JPY, USD/CHF) and some currency crosses.
Pros and cons of the ECN forex broker
The ECN forex broker has both advantages and disadvantages. The pros and cons of the ECN forex broker are as follows.
The pros of the ECN forex broker can be presented in following aspects.
Traders can usually get better bid/ask prices for they are derived from multiple sources.
At certain time traders may trade on prices with no spread or with only very little spread.
Genuine ECN forex broker will pass on the orders to a bank or other
trading participants on the opposite side of the transaction instead of
trading against the traders.
It is very likely that the prices on the ECN forex broker are more volatile.
Traders can take on the role of market traders to other traders on the ECNs since they can offer a price between bid and ask.
The cons of the ECN forex broker can be presented in following aspects.
Many ECN forex brokers do not provide integrated charting or new feeds.
Some trading platforms are not so easy for traders to use or operate.
Since there are variable spreads between the bid and the ask prices, it
may be difficult to calculate stop-loss and breakeven points in pips in
advance.
Forex traders are obligated to pay commissions for each transaction.
It is obvious that there are both pros and cons of an ECN forex broker. Traders have to take many factors into consideration when choosing a forex broker.
Learn how to sort through the chaos and confusion on the web to learn what forex brokers are best for individual currency traders.
What forex traders need to consider regarding the regulatory environment of the forex broker they trade with.
A look at the transaction costs involved in forex trading (the bid ask spread, commissions, and how trades are executed) so that FX traders can properly understand how much their currency broker is charging them.
A look at the technical and value-added features (like news, charts, ability to trade from the web, etc) that currency traders should consider when choosing what forex broker they select.
Forex Broker Types - MM,NDD,STP,ECN
This is small 10 minute education video about the following: the difference between Forex Broker Types - MM,NDD,STP,ECN
- In this video, we're focusing on forex and CFD brokers; this discussion does not apply to stocks and futures brokers.
- The simple truth is that most forex and CFD brokers are trading against
their clients. The details in how this is accomplished vary greatly
from broker to broker. Broadly speaking, we can say there are two types
of brokers: A Book brokers and B Book brokers.
- A Book brokers
may technically be trading against their clients in that they are
taking the opposite side of the trade, but they generally are taking a
risk neutral approach to the market and are looking to immediately
offset the trade. So they are not trading against their client in
spirit, only in technicality.
- B Book brokers will choose what
positions of their clients they wish to offset. As such, they are
willing to take a directional position in the market, and thus may be
trading against their clients in a more material way. For instance,
suppose the B Book broker wants to take a long Euro position in the
market. To do this, they may not offset the short Euro trades their
clients have put on; rather, they will simply take the other side of
these trades.
- A Book and B Book brokers can both run into big
problems -- for themselves, and in turn, their clients -- if the larger
banks and brokerage firms they offset orders with no longer take
positions. This risk is known as liquidity risk. We saw liquidity risk
have a devastating impact on both A Book and B Book brokers when the
Swiss National Bank unpegged the Swiss Franc from the Euro, resulting in
a huge move in a matter of minutes.
- As a general rule of
thumb, the more illiquid instruments a broker offers and the more
leverage they offer the more likely they are a B book broker whose
positions in the market are a significant part of their business. These
types of brokers are giving signals they are comfortable with liquidity
risk, which means they are comfortable taking the other side of the
customer's position.
- B Book brokers have a conflict of
interest that makes it seem like they are dishonest and unethical, but
they can offer their clients significant benefits that A Book brokers
cannot. Namely, their willlingness to take on liquidity risk means they
can offer prices and trading opportunities that would otherwise not be
available. They bundle their customer orders to customers with lower
trading costs, and offer trading free from restrictions like the pattern
day trader rule or any uptick rule. As such, B Book brokers are not
entirely bad or useless. What matters is whether you value the
advantages they offer and that you trust them not to abuse their
position as your counterparty.
- You can ask your broker directly about their dealing desk policy, though many will be coy about their status. This is largely because they feel uncomfortable about admitting their status as the counterparty to your trade, and because they generally do not educate their staff in the nuances of how they operate and make money.
Forum on trading, automated trading systems and testing trading strategies
Sergey Golubev, 2013.07.01 07:19
Just next educational article about ECN and so on - Market Makers Vs. Electronic Communications Networks
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The foreign exchange market (forex or FX) is an unregulated global market in which trading does not occur on an exchange and does not have a physical address of doing business. Unlike equities, which are traded through exchanges worldwide, such as the New York Stock Exchange or the London Stock Exchange, foreign exchange transactions take place over-the-counter (OTC) between agreeable buyers and sellers from all over the world. This network of market participants is not centralized, therefore, the exchange rate of any currency pair at any one time can vary from one broker to another.
How Market Makers Work
Market makers "make" or set both the bid and the ask prices on their systems and display them publicly on their quote screens. They stand prepared to make transactions at these prices with their customers, who range from banks to retail forex traders. In doing this, market makers provide some liquidity to the market. As counterparties to each forex transaction in terms of pricing, market makers must take the opposite side of your trade. In other words, whenever you sell, they must buy from you, and vice versa.
The exchange rates that market makers set, are based on their own best interests. On paper, the way they generate profits for the company through their market-making activities, is with the spread that is charged to their customers. The spread is the difference between the bid and the ask price, and is often fixed by each market maker. Usually, spreads are kept fairly reasonable as a result of the stiff competition between numerous market makers. As counterparties, many of them will then try to hedge, or cover, your order by passing it on to someone else. There are also times in which market makers may decide to hold your order and trade against you.
There are two main types of market makers: retail and institutional. Institutional market makers can be banks or other large corporations that usually offer a bid/ask quote to other banks, institutions, ECNs or even retail market makers. Retail market makers are usually companies dedicated to offering retail forex trading services to individual traders.
Pros:
- The trading platform usually comes with free charting software and news feeds. (For related reading, see Forex: Demo Before You Dive In.)
- Some of them have more user-friendly trading platforms.
- Currency price movements can be less volatile, compared to currency prices quoted on ECNs, although this can be a disadvantage to scalpers.
Cons:
- Market makers can present a clear conflict of interest in order execution, because they may trade against you.
- They may display worse bid/ask prices than what you could get from another market maker or ECN.
- It is possible for market makers to manipulate currency prices to run their customers' stops or not let customers' trades reach profit objectives. Market makers may also move their currency quotes 10 to 15 pips away from other market rates.
- A huge amount of slippage can occur when news is released. Market makers' quote display and order placing systems may also "freeze" during times of high market volatility.
- Many market makers frown on scalping practices and have a tendency to put scalpers on "manual execution," which means their orders may not get filled at the prices they want.
How ECNs Work
ECNs pass on prices from multiple market participants, such as banks and market makers, as well as other traders connected to the ECN, and display the best bid/ask quotes on their trading platforms based on these prices. ECN-type brokers also serve as counterparties to forex transactions, but they operate on a settlement, rather than pricing basis. Unlike fixed spreads, which are offered by some market makers, spreads of currency pairs vary on ECNs, depending on the pair's trading activities. During very active trading periods, you can sometimes get no ECN spread at all, particularly in very liquid currency pairs such as the majors (EUR/USD, USD/JPY, GBP/USD and USD/CHF) and some currency crosses.
Electronic networks make money by charging customers a fixed commission for each transaction. Authentic ECNs do not play any role in making or setting prices, therefore, the risks of price manipulation are reduced for retail traders. (For more insight, see Direct Access Trading Systems.)
Just like with market makers, there are also two main types of ECNs: retail and institutional. Institutional ECNs relay the best bid/ask from many institutional market makers such as banks, to other banks and institutions such as hedge funds or large corporations. Retail ECNs, on the other hand, offer quotes from a few banks and other traders on the ECN to the retail trader.
Pros:
- You can usually get better bid/ask prices because they are derived from several sources.
- It is possible to trade on prices that have very little or no spread at certain times.
- Genuine ECN brokers will not trade against you, as they will pass on your orders to a bank or another customer on the opposite side of the transaction.
- Prices may be more volatile, which will be better for scalping purposes.
- Since you are able to offer a price between the bid and ask, you can take on the role as a market maker to other traders on the ECN.
Cons:
- Many of them do not offer integrated charting and news feeds.
- Their trading platforms tend to be less user-friendly.
- It may be more difficult to calculate stop-loss and breakeven points in pips in advance, because of variable spreads between the bid and the ask prices.
- Traders have to pay commissions for each transaction.
The Bottom Line
The type of broker that you use can significantly impact your trading performance. If a broker does not execute your trades in a timely fashion at the price you want, what could have been a good trading opportunity can quickly turn into an unexpected loss; therefore, it is important that you carefully weigh the pros and cons of each broker before deciding which one to trade through.
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