Blatant Price Manpulation by Market Makers

A short while ago I wrote about the differences between the two main forex broker types, namely ECN brokers and Market Maker or Single Counterparty Brokers (see here). At the time I said that the problem with a Market Maker broker is that they’re taking the other side of your trade and hence there’s a huge conflict of interest and a great temptation for them to tweak their prices in their favour. There was a classic example of this yesterday during the Crude Oil Inventories release. I was following the Crude Oil CFD offering on an unnamed brokerage platform. Now whilst this broker’s forex quotes are a proper ECN (which is why I’ll trade with them), their CFD isn’t though I don’t know who is providing the quotes on their platform. Anyway, take a look at what happened as the market approached the post-release lows.

 

Crude Oil CFD

 

See that huge spike on the lows? I was watching the price there and the spread, which was a fairly tight 2 or 3 ticks suddenly went 20 wide as the quote provider fished for stop orders below the low. It did this two times in quick succession and then it was back to 2 or 3 ticks wide again. Compare this with the Crude Oil futures chart:

 

Crude Oil futures chart
FYI the two other broker CFD’s offering that I had accounts with (OandA and AxiTrader) were both fine with no spikes. I’ve said it before and I’ll say it again: don’t trade with a single-counter party/market maker broker on small time frames as the temptation may well be too great for them. I should just qualify this slightly: it does depend on the broker, some market maker outfits offer fixed price spreads and in general they won’t try this sort of thing on. Some of the better brokers will value their reputation too much to try it on as well so you may find that your broker is OK. You have been warned though!
For my part, I only trade CFD’s occasionally and fortunately I wasn’t in a position at the time. I’ll never trade Crude Oil CFD’s with this broker’s platform again though.

 

Metatrader Tip: Code for Cancelling All Pending Orders

There’s a rather nasty “gotcha” that one has to look out for when working with MetaTrader. It’s to do with iterating through a list of orders when you’re actually making changes to the order list. Take a look at this code to cancel all pending open orders.

void CancelOpenOrders()
{
   for(int i = 0; i< OrdersTotal(); i++)
   {
      if(OrderSelect(i,SELECT_BY_POS,MODE_TRADES) == false) break;
           
      if ( OrderType() == OP_BUYSTOP || OrderType() == OP_SELLSTOP )
      {
         if (!OrderDelete( OrderTicket() ))
            Print(“Delete Open Order failed: “,GetLastError(), 

             ” => “,ErrorDescription( GetLastError() ) ); 
      }
   }
}

At first glance there doesn’t look to be anything wrong with this code but if you come to use it you’ll find that it won’t delete all your open orders.  The reason why it doesn’t work is rather subtle but as it crops up regularly it’s worth getting to recognise it. Think about what happens if there are two open orders so OrdersTotal() returns 2. The first iteration (i = 0) it deletes the first order successfully, and then at the head of the for loop then it increments i  so now i = 1 and does the test to see if i < OrdersTotal(). Since we’ve now deleted one order, OrdersTotal() now returns 1 as there is only one outstanding order. This means that the i < OrdersTotal() condition now fails and it finishes the loop without deleting the second order.

The correct way to do it is to save the original order total in a variable and to iterate downwards so that you’re deleting the last order first. This way you’re not affecting the remaining order indices as you delete orders.

void CancelOpenOrders()
{
   int origOT = OrdersTotal();
  
   for(int i= origOT-1; i>=0; i–)
   {
      if(OrderSelect(i,SELECT_BY_POS,MODE_TRADES) == false) break;
           
      if ( OrderType() == OP_BUYSTOP || OrderType() == OP_SELLSTOP )
      {
         if (!OrderDelete( OrderTicket() ))
            Print(“Delete Open Order failed: “,GetLastError(), 

          ” => “,ErrorDescription( GetLastError() ) ); 
      }
   }
}

As a matter of interest, this same issue crops up in other programming situations where you’re deleting or altering things as you iterate through them so it’s always worth be aware of when you’re doing this.

Is Trading Like Poker?

Is trading like poker? A strange question you might think but actually there are a number of similarities and making the comparison can help improve ones trading strategy. Adam Hartley explores the similarities and differences between the two and finds that learning about poker can improve trading performance.

There has recently been a great upsurge in interest in the game of poker, not least because of the recent TV coverage of the World Poker Tour where you can see the hands that the players have and watch their decisions as they make bets for huge sums of money. Traders are of course making similar decision with large amounts of money on a daily basis and like professional poker players, looking to make a living from this process. Can studying the habits of winning poker players help traders improve their performance?

Firstly, for those who are not familiar with the basics of the game need to be outlined. All variations of poker (and there are quite a few of them) come down to the relative rankings of 5 cards in each players hand. Players bet on their hand according to how good they think it is and at the end the player with the best hand takes all the money in the pot. The hands are ranked according to how likely they are to occur with the rarer hands beating the more common hands. The rankings are as follows:

High Card:             if all else fails the highest card wins
One Pair:                having a pair, i.e. two cards of the same rank
Two Pairs:              having two different pairs
Three of a Kind:     three cards of the same rank
Straight:                  a sequence of five cards in ascending order of any suit
Flush:                      five cards of any rank but of the same suit
Full House:              three of one rank and two of another rank
Four of a Kind:        four cards of the same rank
Straight-Flush:         a straight but all cards also the same suit

Some variations of poker give you more than five cards and the best five cards are selected to make the final hand. Most variations involve several rounds of betting on the cards as they are dealt out before the final showdown. Some have communal cards that everyone uses whereas other variations keep the cards separate to each player.

Having dealt with the basics of how the game is played the next question is how do professional poker players play the game and what can traders learn from this?

Great Expectations

The first and most important point is that poker, like trading, is all about expectations. This does not mean looking forward to making all that money, rather the expected value of a bet is the amount that you earn on average from it. If a bet of $1 will win the pot of $10 25% of the time and the rest of the time results in the loss of that $1 then the expected return from the bet is:

0.25 x $10 + 0.75 x -$1 = $1.75

That is to say, on average you will make $1.75 every time you find yourself in this situation and you make the bet. This is clearly a good bet to take as it makes you money on average. On an individual basis each bet could go either way but over a period of time it will average out to a clear profit. On the other hand if the bet will only win 5% of the time then the expectation is

0.05 x $10 +0.95 x -$1 = $-0.45

This is clearly not a good bet and over time will lose you money. That’s not to say that you cannot win this bet and some times you will be lucky but over a period of time you will be a net loser.

In the famous Market Wizards books Ed Seykota said  that there are good trades and bad trades, and winning trades and losing trades and that these are not the same things. A good trade is one with a positive net expectation and a bad trade is one with a negative expectation and these are not the same as winning and losing trades. The job of a trader or poker player is to take good traders or bets and not bad ones and to let the winning and losing take care of itself. This is often something that people have problems with: they get hung up on the winning and losing rather than whether what they are doing has a positive expectation. If the expectation is positive then the numbers will work out in the end. One way to think about it is to think that when you are making a trade or bet you are buying a piece of expectation and that if it is a good quality piece of expectation then over time this will crystallise into actual money but that your job is to seek out and purchase the best pieces of expectation that you can buy. If you make a good trade or bet then irrespective of the actual outcome you need to tell yourself that you’ve done the right thing and to keep on doing it. The worst thing that you can do if you get a run of losing bets or trades is to start deviating from a positive expectation strategy.
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Having an Edge

In order to have a positive expectation you need to have an edge. If there is no edge then you cannot get a positive expectation. There is a good reason why there are no professional roulette players: you cannot get a positive net expectation from any plays because of the house edge.

In poker they talk about how “tight” a player is. That is how disciplined and selective he is about what cards he chooses to play. One of the basic mistakes that rookie poker players make is in playing too many starting hands (the cards that you are initially dealt) that don’t have a positive expectation. In other words they are far too “loose”. A professional player knows that only the best starting hands are going to make money over the long run and so they spend most of their time folding their hands, waiting patiently for the best quality ones to come along. A poor player on the other hand will bet money on mediocre hands far too much. And what happens to this money? It ends up in the pockets of the good players who have had the discipline to wait for those big hands and to rake in big winning pots as a consequence.

A professional poker player can almost guarantee to make money over the long run in a loose game being played by relative amateurs. His edge in this case is in playing only the best quality cards and waiting patiently until they come along. You can try this for yourself with on-line poker games where you can even play with pretend money. Because there is no real money for stake people tend to bet on anything. If you play a disciplined and tight game then you will always come out ahead in the long run.

 

What’s Your Edge?

So how does what we’ve said so far relate to trading? As with poker, trading is all about expectations, making good bets and not bad bets, buying good pieces of expectation and letting the winning and losing trades come and go. Its about having an edge. Ask yourself with your trading what your edge is. Why is it that you expect to make money from what you do. A market maker has an edge which is the spread in the market that he is trading. Because he gets the right side of the bid and offer he has a positive expectation on his trades. Sure there will be times when the whole market turns bid and he’s the one selling to all those buyers but he still has an edge which will always win out. For the rest of us this spread is part of the costs that we have to bear when trading and these costs are significant. Our net expectation on each trade must be greater than all our costs per trade for trading to be worth doing at all.

Using this analogy of tight poker playing when thinking about trading can help you become a better more disciplined trader. When contemplating a trade, ask yourself are these the best trading conditions and do I have a genuine edge here or should I wait until better “cards” come along? Unlike in poker when you are forced to bet at least twice each time the dealership passes round the table (the small and big blind bets are forced bets that players have to make before they even see their cards) in trading there is no cost in not trading so sitting there waiting patiently for the right conditions to come doesn’t cost anything. It’s well worth remembering that you don’t have to trade and there is no point in doing so unless the conditions or trade set-up give you an edge. Over-trading is the trading equivalent of playing too loosely with the same devastating financial consequences.

 

The Only Game in Town

One of the most striking differences between poker and trading is the level at which the game is played. In poker you can get games with the stakes as low as a couple of cents for each bet all the way up to no limit games where tens of thousands of dollars are at stake. As you can imagine the higher the stakes the better the quality of the players. Fortunately the rookie player can start off at the bottom where the amounts risked are manageable and the opposition relatively inexperienced.

With trading on the other hand whilst you can still make small sized trades when starting out the opposition that you are playing against includes the best on the planet! There is only one game in town for any given market so if you want to trade that market then you are in effect doing the trading equivalent of sitting down to play at the poker table with seasoned professionals. Clearly someone starting out in poker would balk at having to do this but they are quite happy to start trading with little experience at all. It is no surprise that the vast majority of traders lose money when it is viewed from this perspective as they are playing in a zero-sum game with the best players who have learned how to win at this game. If you want to think of it in Darwinian terms then survival of the fittest certainly applies to trading: the losers drop out of the game leaving only those who win and new players who have just joined the game.

The moral of this observation is to be cautious with trading. I have often seen people who have been successful in other areas of business and who’ve made some money who come along thinking that trading is going to be easy. For the reasons pointed out above it is not easy as you are up against the best players in a zero-sum game. That’s not to say that trading can’t be successful but that it requires discipline and patience to succeed.

 

On Tilt

No doubt you’ll not be surprised to learn that there is an important psychological aspect to poker just as there is in trading. There is of course the element of reading opponents and bluffing but in addition to this there is the issue of managing your own emotional state. There is an expression in poker for when a player starts playing emotionally and irrationally, it’s called going “on tilt”. This very often happens after someone has taken a big loss, they try to make it back by playing hands that they shouldn’t and making bets that they shouldn’t. Other players love it when a player goes on tilt because it means that they will make more money from his bad decisions.

This is of course a common failing also with trading; monitoring and managing ones emotional state is an important part of the trading process. As traders we’ve all experience this but it is vital to learn to monitor ones emotional state before placing trades. If you go “on tilt” then stop trading. Remind yourself that you need to be looking to buy good expectations and the money will take care of itself.

 

State of Mind

Top professional poker players need to keep a clear head. Contrary to what you might think, the vast majority don’t drink alcohol at the table as they need to be able to do the calculations and make the assessments with full concentration for hours at a time. In trading one’s state of mind is often overlooked, trading when not feeling 100% can lead to mistakes and making trades which don’t have good expectations. Remember, unlike in poker, it costs you nothing not to trade.

 

Conclusions

So what have we learnt from this comparison between poker and trading? Firstly that without an edge of some kind there is no point in making a trade. Waiting with discipline for the right “cards” or trading conditions to come along is the basic edge and once you deviate from this then your edge is gone. Monitor your emotional state. Are you “on tilt” – should you walk away from the table. Remember there’s only one game in town and you are playing against professionals so unless you trade in a professional manner they’ll end up taking all your money! Stick with your strategy, buy “good expectations”, trust that the numbers will work themselves out and you will succeed.

Web Resources: Forex Factory

This is one of a series of articles about useful trading web-resources. This time it’s Forex Factory

Forex Factory almost needs no introduction as I expect that almost everyone knows about it. However, for those that don’t it’s probably one of the largest and longest established forex trading portals around. It’s a site which I personally use on a daily basis and has a number of different components to it which are are discussed below

Economic News Calendar

I use ForexFactory each day for it’s economic calendar where news releases are graded according to expected impact with a traffic light systems of yellow, amber and red. What’s more if you log in then it sets the release times to your own time zone which is very convenient. You can drill down on each release to find out details about it, who compiles it, historic release data and a chart of past values. About five minutes before a release if you refresh the page you get a little green update icon by the release and once the news has been release, clicking on this icon will update the page with the actual release value. Note that this isn’t instantaneous but it’s usually within about 30 seconds of the release – so it’s not a substitute for a squawk box but very useful nonetheless for finding out the release figure.

 

Click image to enlarge

Forum

The Forex Factory forums are huge and well used. You can find all the usual discussions about trading strategies, EA’s and brokers. In general, the “signal to noise ratio” on the forum is rather low – there are a lot of micro-lot traders out there looking for some EA to make them rich and one has to wade through a lot of drivel to get to the useful nuggets. Having said that, there are also some really good threads on there from what appear to be successful traders, some of whom generously teach their methods on their threads. It’s a great place to get ideas though as I said one has to mine quite hard to come up with something of substance.

News

On this page there are plenty of news articles and analysis, supplied mostly by news services which are trying to get some business (which is fair enough). Personally I find watching such news feeds a distraction from trading with no real value but that’s just me.

Brokers

ForexFactory have a great broker summary page where you can see a comparison table of some of the top forex brokers and their real-time spreads. Of course, there are always limitations to these sorts of tables but the FF staff have done some work in whittling down the list to those who are supposed to be properly regulated. They do state that FF gets a fee for the listing so it’s not entirely unbiased and representative and the table will therefore only consist of brokers who are willing to pay the fee but it’s a useful starting point

Markets

This is a useful little page if you want a quick overview of the market, along with a simple charting app which allows you to view one market on any time frame from 1 minute all the way up to monthly. Of course most traders will have their own charting but it’s a useful page for when you’re on the go.

Traders

This page allows you to follow traders who have signed up to their Trade Explorer service. This extracts live trades and analysis from trading accounts and posts this information on a summary table. This might be of interest for those who want the thrill of competing against other traders and coming top of the trading leaderboard and the table is populated by people with insanely high returns as you’d expect. Personally it’s not my cup of tea but each to their own

Conclusion

Forex Factory is a well established portal that is well used though definitely with a small retail trader bias. Nevertheless it has some very useful features and is definitely worth a regular visit.

Swap Rates – The Hidden Cost of Trading Forex

Retail traders are these days very much aware of the different spreads that brokers offer but a surprising number are completely ignorant when it comes to the cost of carry, or swap rates that are charged when positions are held overnight. Whenever you hold a forex pair overnight you should earn the overnight interest on the long pair and pay the overnight interest on the short pair. This amount is deducted or credited to your account each evening on the New York close. For proper interbank trading the interest rates charged will be close to the actual prevailing rates in the market but for retail forex trading brokers are free to set their own rates. Typically they might make a spread around the LIBOR rate so if the EUR overnight rates is 3.0% (remember those days!) then you’d pay 4% if short and received 2% if long. Remember: there will be a similar spread on the other half of the pair being traded as well. It’s amazing how much variation there is in swap rates between brokers. To compare you need to know what “swap points” are: this is the amount charged or credited in USD for holding 1 full lot (usually 100k units in Mt4) overnight. You can find out what your Metatrader broker is charging by going to the Market Watch window in Mt4, right-clicking on the symbol and selecting “Specification”. This will bring up the contract specification window

In the example above for the broker LMAX you can see that you get charged a whopping 4.39 USD if you’re long GBPUSD overnight and charged 3.69 if you’re short. What’s more, since spot transactions are for settlement in two days time, on Wednesday night your trade settlement will rollover to Monday the following week so you’ll get charged for three nights rollover in one hit. Ouch!

Below are some swap rates taken from a few brokers for GBPUSD. When comparing different brokers it’s worth checking what lot size they are assuming – these figure are all for 100k lots. You can see a more comprehensive comparison table (for 10k lots) here.

LMAX         -4.39 / -3.69
Axi Trader   – 1.80 / -0.80
Pepperstone  -2.26 / -2.03
GKFX           -1.22 / -0.75
OandA          -0.90 / +0.10

It’s quite amazing the differences that exist between brokers. I know a few traders who state that in their opinion many brokers actually make most of their money from the overnight swap rates rather than the commission or spread as these overnight charges really do add up, especially if you’re holding positions for a while.

Here are a few points to consider

1. For day-traders swap rates aren’t an issue. If you’ve closed out all your positions by the New York close then you won’t be charged any swap rate. The one exception to this is the broker OandA who along with their unique “any position size trading” also have a unique “charge swaps or roll-overs continuously” policy. What this means is that even if you’re only in a position for a few minutes you’ll be charged, based on the fraction of the full day you were in the position for. Fortunately OandA’s swap rates are pretty reasonable but it’s something to bear in mind

2. For position traders swap rates are a big deal. Whilst the charge for one day may only be a pip or so, if you hold a position for a month then this charge really adds up. Now in the good old days where interest rates were a decent amount you could actually earn interest on your position if you were positioned the right way on the right pair but these days of ZIRP you’re going to be charged every time. It’s an unfortunately but necessary part of trading but you do need to watch how much you’re being charged as in some cases the charges are quite a blatant rip-off.

3. This swap / roll-over charge also applies to all futures markets. However, in that case this is built in to the overall price as there is no roll-over but instead a single expiry. You will find that each day your futures contract will have gone up or down by a small amount relative to the spot price. However, in this case the daily change will be using the proper interbank interest rates. This does also mean that if you’re trading a CFD (e.g. Crude Oil) then there will be a daily roll-over cost and once again the broker is free to set whatever rate they want. As a general rule, from a swap rate point of view, it will always be cheaper to trade a futures contract than a CFD or retail spot rate.

3. If you’re doing reasonable volume with a broker then you might find that there’s some scope for negotiation on these swap rates. I’ve successfully negotiated a reduced swap rate on UK stock CFD trading some years back with a broker as I was doing reasonable volume with them.

Conclusion
The key thing to remember here is that many retail brokers know that most retail clients don’t think about swap rates when they’re choosing their broker and for some this is an opportunity to rip-off the client. It’s not as if they’re even taking on any risk as part of this: the extra charge over and above the interbank interest rates are just pure profit. So it’s worth checking your broker to see how much they’re charging

Metatrader Tip: Offsetting Hedged Orders

A quick tip for beginners who are using Metatrader 4. If you’ve got two opposing hedged orders, say long 1.0 lots of EURUSD and short 1.0 lots of EURUSD then of course you are hedged. However, if you want to close out both positions rather than legging out of them (i.e. closing each individually) which carries a certain risk if the market moves whilst you’re in the process of closing them out, then you can simply offset one order against the other. What’s more this way you won’t incur so much commission charges as the second order is now just treated as a closing out order so you only get charged for one round-turn instead of two.

 

To do this, double-click on one of the orders to bring up the order ticket. In the Type field select “Close By”, this will then give you a list of orders which will offset this first order. Select the appropriate order in the list and then click on the Close button and voilá, you’ve offset your two hedged orders.
Note that the offsetting orders don’t need to be the same size. You can be long 1.0 lots and short say 0.5 lots and you can still do this offsetting which will result in a single long position of +0.5 lots.

 

click on image to enlarge

 

Broker Review: OANDA

When you search for reviews of forex (or any broker) on-line you’re often left none the wiser as you just don’t know whether it’s a genuine independent review or something spammed up by the brokers themselves. I’m only going to review brokers that I’ve personally used and I can confirm that I have no personal interest in each broker other than having in the past, or currently using them. First up is OANDA.

Background

OANDA are one of the older forex brokers around and have always been a bit “different”. The original aim with OANDA when it was set up by Olsen and Flumm (the name is a contraction of “Olsen and Associates”) was the democratisation of forex. To this end they offered what at the time was a unique take on forex trading with completely variable lot sizes and also real-time swap payments. To this day, these two things mark OANDA out from the crowd. The variable lot size is a particularly attractive proposition for newbie traders: you can literally trade any size in a forex pair from 1 unit upwards, so you can for example take a position of 1 Euro of EUR/USD so 1 pip is $0.0001. This makes it ideal for when you don’t want to risk much money and this ultra-fine granularity also means that you can fine-tune the amount you risk per trade as precisely as possible.

 

They were bought out by a venture capital fund a few years ago who wanted to steer OANDA towards the gambling and casino end of the market. To this end they brought out lots of stupid innovations that were of no use to serious traders at all and only resulted in pissing off their existing clients big-time who all started leaving in droves. Eventually they saw sense and have gone back to their core business.
OANDA are a Market Maker type of broker: see here for an explanation.

Platforms

Their trading platform fxTrade, looks a bit old fashioned by modern standards. It does the job but their list of indicators is rather limited and there is not much scope for customisation. Their data doesn’t go very far back and there is no scope for backtesting or programming at all. One great thing about them though if you trade short term is that they offer sub-minute charts with 5s, 10s, 15s and 30 second charting all available. Also, they are one of the few people who offer mid-price charts rather than bid charts. This is especially useful during news releases where bid price charts can get distorted downwards as the spread widens.

 

These days they also offer MetaTrader though their demo version doesn’t allow you to hedge which may be a problem and their live version “simulates hedging” (whatever that means – I’ve not actually used their live Mt4 offering so far).

 

OANDA’s FX Trade platform – click image for larger size

Markets, Spreads & Swaps

OANDA used to offer fixed spreads but these days the have “dynamic spreads” which basically means that when the market is really quiet they are quite tight (1.5 was apparently the per-tick average of February 2016 for EUR/USD) but when things get more volatile the spread can widen. They used to widen their spreads to stupid levels (20 pips) during news releases and to keep them wide for a long time afterwards (double their usual spread) though thankfully they’ve now stopped doing this and they revert to normal levels much faster now.

 

Their swap rates are actually pretty good compared with most brokers though the fact that swaps are accrued on a real-time basis rather than at the end of the day is a drawback, especially in these straightened time when you can never actually earn money on the carry. Of course it does avoid the “Wednesday Night Triple Rollover Curse” which is always especially harsh.

 

As well as all the currency pairs you could want, including plenty of minor rates, they also offer CFD’s on all the major markets including indices, bonds and commodities. Their CFD spreads are reasonable (2.7 pips on Crude Oil, less than 1 point on the S&P 500) though it’s a shame that their philosophy of ultra-small lots doesn’t extend to their CFD offering which are comparatively chunky by comparison.

API

They offer an API – their old java API is now being phased out in favour of a free lightweight JSON/REST service which is more scalable and easier to support and to program against.

Summary

As far as Market Maker Brokers are concerned, OANDA are one of the better ones. I basically trust them and I keep a small account with them largely because their small minimum size allows me to test things out in tiny sizes if I want. I wouldn’t use them for short-term trading as their spreads are too large but I like their second charts and their mid-price charts. If you’re just starting out and want to dip your toe in the water I’d recommend OANDA for learning the ropes because of their small trade sizes. What’s more their uniquely small trading size does mean that you can size your trades exactly, rather than having to compromise with larger granularity lot sizes. This is especially important for trading larger time frames. I personally know of several serious and successful traders who use OANDA for their trading in reasonable size.

Different Types of Retail Forex Account

Forex trading has come a long way for retail traders over the last few years. I remember starting out with CMC brokers a good fifteen years ago. They had a spread you could drive a truck through but they were one of the first outfits which catered for retail forex traders. These days there are no end of brokers offering some great services with really tight spreads. Beginner traders in forex may not be aware of this but there are in fact different types of forex accounts and one should think very carefully about which type you choose when starting out. Let me explain a bit.

Single-Counterparty or Market Maker Account

When you take a trade, there’s always someone taking the other side of it. With a single-counterparty broker it’s the broker who quotes you your two-way price and who takes the other side. The idea is of course that with enough two-way business going on they’ll be fairly well hedged and will be making the spread each time as their profit. All well and good but in practice it’s not as simple as this. The broker may well not have enough business to be properly hedged so then they need to decide what to do about it. Fortunately, they are party to a great deal of extra information to help them make their mind up. For one thing they can and do track each client to see if they know what they’re doing – they typically divide their clients into two camps, the A book and the B book. If they’re good traders then the broker may well just hedge their trade (or even duplicate it if they really trust the trader). If the client is no good then they’ll simply take the other side of the trade, the old “bucket shop” approach. For those who aren’t familiar, a bucket shop was an old stock broking firm which would take orders from clients but instead of actually executing them would throw the ticket in a bucket and just take the other side of the trade knowing that most of the traders were going to lose money so they would profit.
An original bucket shop
Now I’m sure that astute readers can see that there is a great conflict of interest here for the broker who is making the prices themselves and might also be on the other side of a clients trade. For starters, the broker knows exactly where your stop loss and take profit orders are. Obviously, the temptation to nudge the price to hit your stop loss or to hold back the market just before your take profit level would be considerable. What’s more there are a number of tools for Metatrader brokers which will allow them to nudge prices in precisely this way so don’t think that it never happens because it does. Now, I’m not saying that all firms do this – for larger firms who’ve been around for a while and who have a reputation to uphold they may well shy away from such behaviour but traders should very much be aware of this possibility. I would say that in general, the larger the time frame that is being traded, the less of an issue this becomes: no broker is going to nudge the price several hundred pips to knock out your stop so you should be fairly safe there but if you’re trying to scalp a few pips with a market-maker account then you should be very wary.

ECN Account

Futures traders might be surprised to learn that such things as Market Maker Accounts even exist. In their world there is a single exchange where all the trading takes place. There’s no question about the price or the quote and there’s no scope for skulduggery (except directly in the market itself!) and everything is above board. Fortunately such things exist in the forex world as well with ECN accounts whereby some liquidity providers (usual banks) provide constant two-way quotes on the “exchange”. I say “exchange” but it’s not like there’s only one, you still have the problem of there being no single forex market as such but at least all these liquidity providers are (presumably) quoting the same price across a large number of platforms so you’re basically getting the correct global price. As the broker is no longer getting the spread they are instead compensated by the trader paying a commission. In general, even after commission, ECN trading is tighter than most Market Maker Accounts. What’s more with ECN accounts there’s none of the shenanigans that might go on with the Market Maker Accounts. The conflict of interest with the broker is now removed and in fact they want you to succeed as then you will be around to pay them commission for longer. In fact the only downside to ECN accounts is that some brokers have a higher minimum account size than the Market Maker Accounts but these days it can be as small as $1k.

 

an ECN broker will have multiple liquidty providers

 

So there you have it. Two types of forex brokerage account but two very different beasts. Is there any reason for using a Market Maker Account then? Well, one reason might be if you want to trade big size and if you want to be sure of what your price is for that size. Your market maker broker might say that it’s quote is good for up to $10 million for example whereas on an ECN you’d be taking out several layers of the depth of market if it’s relatively small and you’d have to worry about hitting an “air pocket” if you take out all the bids or offers. This would therefore be a legitimate reason for using a Market Maker Account. This reason aside, personally I can’t otherwise understand why anyone would willingly trade with a Market Maker Account if they didn’t have to and I only use ECN type of accounts. In due course I’ll be posting various reviews of brokers which I’ve personally used.