Triantus Shango
Sergeant Major
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DISCLAIMER:
k guys, everything you are gonna read in this post is in no way meant to recommend or endorse this product or company against another one and so on. also, as i am performing some due diligence in my search for the next trading venue, this is a snapshot of all the info i came across, and as such, i suddenly realized that maybe this could be helpful to newbies who are just starting out. god knows i wish someone had told me all this when i started out. anyway, whatever conclusions i put forth are solely my own, etc… and since i do not know everything, i am sure i must be mistaken on quite a few things. so the more experienced traders out there reading this, by all means, please correct me where necessary.
NOTE: just attached 1 more PDF, explains what goes in a data stream, interesting inside look even if superficial.
ok that being said, let's consider first some terminology: ECN can mean 'Electronic Communication Network' or 'Electronic Crossing Network'. MB Trading calls the latter an EXN. go on wikipedia and look it up: Crossing network - Wikipedia, the free encyclopedia .
also lookup ATS, which is called MTF in Europe (LMAX is an example of a European MTF on which one can trade SPOT FX and CFDs, just recently opened by Betfair, one of the largest betting exchanges in the world)--[ UPDATE: Betfair recently sold LMAX through a MBO (Management Buyout): http://forexmagnates.com/lmax-gets-sold-to-management-valued-at-3-6-million/ ], and ECN, which is a subset of ATS (in the US). follow the external links. go to the institutional service provider websites and read the literature and you'll get a sense of where the technology is at today and what is possible. hint: all the retail pools at all these RFEDs and retail ECNs can all be aggregated and put out there on a marketplace platform where both the orders from the institutionals and the retail traders can be matched up once the matching engine algorithms breaks them down properly.
also, read about 'dark liquidity' here:Dark liquidity - Wikipedia, the free encyclopedia as it will highlight some important points pertaining to the whole price discovery mechanics and order matching.
then this: Pipeline Settles With U.S. SEC Over Dark Pool Claims - Bloomberg
and even though the former concerns the equity market, and the order sizes are orders of magnitude larger than in the retail FX market, it illustrates a similar principle at work, no matter the scale. especially pay attention to this paragraph:
'The problem Pipeline faced, the difficulty in matching blocks when investors want to trade, is one many operators of dark pools deal with as they build their venues and seek more orders. Brokers running dark pools often address this by enabling a stream of orders from their own firm’s market-making units or by allowing outside automated traders or high-frequency firms to fill that role within their system, Tabb said.'
and so, if the big guys do it…. you get the picture.
now let's take a look at how bad it can really get and how good it could be, and in-between.
take-away #1: let's say you're a small retail trader and your orders are small, meaning some fraction of a standard lot (which is equivalent to 100K base currency units in the market). from what i understand by looking at the institutional trading platforms and searching the web, the real market, that is, the prime brokers, the banks, the hedge funds, corporates, high net worth investors, retail brokers/dealers exporting their retail liquidity pool, that is, the liquidity aggregated from all their retail clients' orders (the ones large enough such as FXCM, GAIN Capital, Interactive Brokers, Dukascopy Bank SA to name a few) and so on, will not be your counterpart if you buy, for ex., less than 10 lots of eur/usd. anything less than 1M is too small. on institutional platforms standard order sizes are preset to 1M, 5M, 10M, 15M, 20M, 25M, sometimes 50M. actually the order size buttons can be configured to whatever the institutional trader wants, so it could even be 100M.
now, what does this mean for the execution of the retail trade? it means that:
1- if the broker/dealer has enough retail clients trading at the same time you are trading (that is, there is sufficient liquidity available on your broker/dealer order book on their network, not the order book sitting on another network belonging to another broker/dealer), then they can match your order against the order of another of their retail client (that's what a ECN=EXN Electronic Crossing Network means), but it does not mean they do it--some do and some don't;
2- so, if the broker/dealer does not have enough retail clients trading at the same time you are trading, and thus volume/liquidity is way down in the market or marketplace they are creating for their retail clients, then you might not find another retail trader counterpart at the price point you want; and since you order is too small to offload into the institutional market, the broker/dealer only has 2 choices at that point: take the other side of the trade, or let the trade slip until it can be matched to another client order on the book. but since every broker/dealer out there is making a point in their marketing literature of telling us that there is no or very little slippage because the FX market is so huge (yes, the real (institutional) FX market is huge, but it doesn't matter at the order size retail traders play with because in case (2) we do not get access to it because our orders are too small, especially the minis and micros), they will try to execute your order as quickly as possible and to do so in a situation of low liquidity, it can only be done if the broker/dealer takes the other side of the client's trade. and now we have potential conflict of interest. (more about this in a sec.)
3- but if the broker/dealer has a good technological infrastructure, say for example, they are hooked into Integral (an FX aggregator), or Currenex, or FXAll, or LavaFX, or HotSpotFXi, or Portware, and so on, and if their business model is not to engage in proprietary trading against their client base, then as in case (2) above, they still can be the counterpart to a client's trade but only as a middleman passing the client's trade along to be matched to another order coming in from the various aggregators i mentioned, thereby limiting their risk exposure and thus obviating the need for them to trade against the clients because they have access to so much liquidity now that it is no problem filling all the small orders coming from their retail client base. in this case, the broker/dealer does not need to be a market maker any longer as in case (2).
in this regard, i think brokers/dealers have to be in the middle as a counterpart (and not necessarily as a market maker) for clearing/settlement purposes because after they inject their clients aggregated orders into the 'real' market, once those orders need to be settled, they will not be settled retail trader by retail trader versus whatever entity took the other side in the real market. in other words, when the retail orders go out in the real market (because the broker/dealer is the one who gets the line of credit from some prime brokerage or bank(s) and extends that credit (as leverage) to the retail client), the other institutional participants will see volume coming from your broker/dealer marked with that broker/dealer ID and not 100s or 1,000s of retail orders each marked with a retail trader's ID.
BUT, and this is a big BUT, just because a broker/dealer seems to fit in case (3) DOES NOT mean that they are not engaging in proprietary trading against their client base. case in point, GAIN Capital--here is what i found on the NFA site, and bear in mind, that in the case of GAIN it was not only the retail clients who were affected, but also the institutional clients:
'On October 27, 2010, NFA's BCC issued a Decision accepting an Offer of Settlement submitted by Gain and Stevens, in which Gain and Stevens neither admitted nor denied the allegations of the Complaint and agreed to settle the case on the following terms: Gain agreed to refund to customers the amount of negative slippage they experienced on the trades that were placed in their accounts between May 1 and July 31, 2009 and which were attributable to the Virtual Dealer Plug-in that Gain used on its institutional and retail servers….'
read the last sentence one more time--a light bulb should go off at this point. a virtual dealer (i.e. deal desk) plug-in used on both the institutional and retail servers.
take-away #2: whether you are a small fish or a big one, if the crooks want your money, they'll try no matter who you are.
take-away #3: no matter who your broker/dealer is, they have the technological means to totally control everything about the price feed clients receive.
as an example of how easy it is for brokers/dealers to do whatever the f%&* they want with the feeds, take a look at the attached screenshot of the admin interface ProTrader/PFSoft provides to brokers/dealers. you can clearly see in the General Settings pane 2 entry fields: one is to set the maximum spike value and the other the minimum spike value: http://pfsoft.com/sites/default/files/pages_galleries/backoffice_1.png
the other URL to their back office software: Discover the world of Protrader | PFSOFT (PFsoft provides a trading platform for brokers/dealers as well as front-end software brokers/dealers will make available for free to the retail customers (parts of the MBTrading client software MBTDesktop and MBTDesktop Pro is built on top of the PFSoft API, if i am not mistaken).
and a better illustration comes from the Visual Trading Systems website, where the company explains what the VT Dealer can do for the brokers/dealers:
VT Dealer | Visual Trading Systems
and a nice logical network map here: VT Spot? Platform | Visual Trading Systems
the few firms that are honest about this will have proprietary cash set aside just for the purposes of trading against their clients, which helps them absorb the losses on those small trades when a minority of their clients are right. it's part of their cost structure. but those companies who have a different cost structure that does not involve eating the losses if their clients's trades are in-the-money, will cheat to get out of the trade at a more favorable price (undue margin calls, spikes, etc).
that being said, here is what i found from GAIN Capital's FORM 10-Q SEC filing (also attached) for the quarterly period ended 30 September 2012, and to their credit, they are at least transparent insofar they admit publicly how the game is going to be played if you step down into the arena with them (i wish the same could be said of the rest of the RFEDs and brokers out there, but sadly not, as they all still cultivate an artful marketing fog):
'UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
GAIN CAPITAL HOLDINGS, INC
We do not take proprietary directional positions to mitigate our exposure to changes in foreign currency exchange rates.
We generate retail trading revenue as follows:
• for trades that are naturally hedged against an offsetting trade from another customer, we receive the entire retail bid/offer spread we offer our customers on the two offsetting transactions;
• for trades that are hedged with one of our wholesale forex trading partners, we receive the difference between the retail bid/offer spread we offer our customers and the wholesale bid/offer spread we receive from the wholesale forex trading partners; and
• with respect to the remaining customer trades, which we refer to as our net exposure, we receive the net gains or losses generated through changes in the market value of the currencies held.
Market Risk
We are exposed to market risk in connection with our retail trading activities. Because we act as counterparty to our retail customers’ transactions, we are exposed to risk on each trade that the market price of our position will decline. Accordingly, accurate and efficient management of our net exposure is a high priority, and as such we have developed both automated and manual policies and procedures to manage our exposure. (<-- it is these procedures that got GAIN in trouble with the NFA)
These risk-management policies and procedures are established and reviewed regularly by the Risk Committee of our Board of Directors. Our risk-management policies require quantitative analyses by currency pair, as well as assessment of a range of market inputs, including trade size, dealing rate, customer margin and market liquidity. Our risk-management procedures require our team of senior traders to monitor risk exposure on a continuous basis and update senior management both informally over the course of the trading day and formally through intraday and end of day reporting. A key component of our approach to managing market risk is that we do not take proprietary directional market positions and therefore do not initiate market positions for our own account in anticipation of future movements in the relative prices of the products we offer. To facilitate our risk-management activities, we maintain levels of capital in excess of those currently required under applicable regulations. As of September 30, 2012, we maintained capital levels of $100.7 million, across all of our regulated subsidiaries, which represented approximately 2.4 times the capital we were required to hold.'
please note that the phrase 'we act as counterparty' does not necessarily entail that the broker/dealer is trading against you, as explained in case (3) above. here is some info in that regard i found on Advanced Markets FX site: http://www.advancedmarketsfx.com/tr_NFA01.htm .
here is the best summary i have been able to find online so far re the mechanics of trading retail. this is from the Dukascopy Bank SA FAQ page where we can read (FAQ :: Dukascopy Bank SA | Swiss Forex Bank | ECN Broker | Managed accounts | Swiss FX trading platform):
'Can Dukascopy Bank SA be the counterparty of my trades?
Notwithstanding the fact that the SWFX – Swiss FX Marketplace is an ECN, Dukascopy Bank SA is the counterparty of all of its clients’ trades. Dukascopy Bank SA sends orders to the interbank market in its own name for hedging purposes. Not all clients’ trades necessarily result in orders sent straight to the interbank by Dukascopy Bank SA. The small size of a trade may have an incidence on the ability of Dukascopy Bank SA to hedge it with its counterparties since the latter may not accept trades under a certain minimum size. Therefore, Dukascopy Bank SA may be obliged to cumulate a certain number of executed trades prior to being able to hedge them in the market. However this depends on hedging counterparties’ minimal lot size and current exposure of already cumulated trades. All traders receive the same data feed and same execution quality whatever the size of their trades.'
also on Dukascopy's site i found this regarding execution (sorry i misplaced the URL):
'Execution
Dukascopy Bank SA has a unique technology to hedge instantly any clients' trades directly with other Liquidity Providers.'
and i like this explanation from Dukascopy Bank SA: on this page they talk about liquidity a little--very interesting, apparently their platform can absorb up 2,000 lots (i think they say it's USD$ 200M) in one click with no significant delays but spread goes up to 4-5 pips as, i guess, the platform is trying to breaking down the order to match it on the ECN--but that's some decent liquidity: SWFX Swiss FX Marketplace Solution :: Dukascopy Bank SA | Swiss Forex Bank | ECN Broker | Managed accounts | Swiss FX trading platform . for comparison, when you go to the Currenex site, scroll further down that page and click on JFX: here is the link i went to, JFX Liquidity - JFX.com - Forex Trading; on this page you will find this: 'Liquidity pool up to $500 million'.
interestingly, FXCMPro is also listed on that page as a white label partner. and what is even more interesting is that Barclays retail FX trading service is an FXCM white label! that is, they use the same software for the client: Trading Station, MarketScope, and the orders are routed through FXCM. i fail to see then what's the advantage of opening an account with Barclays.
anyways, at the end of the day, the problem we, as retail traders face is one of size (being too small) and liquidity, that is to say, if you are too small and there aren't enough other small sized retail orders on the same ECN/marketplace with your order, then how does your order get filled if the broker/dealer doesn't play market maker?
therefore the more volume a broker/dealer can attract, the better for the bottom line and the better for the retail clients as the RFED can now improve its balance sheet, which in turn helps get a larger credit line from the prime broker(s) it needs to gain access to the real/institutional/interbank market, also helps get better pricing (spreads) that can be passed on to the retail clients, and improved liquidity. that is perhaps why in the early days, when most of the RFEDs were not large enough in terms of retail volume to have a sustainable business, they had to resort to shady practices in order to grow the business and survive long enough until they became able to switch to practices that, although initially not sustainable, had now become sustainable. (not trying to excuse anything here, just thinking out loud).
some people might now point out that MB Trading has too small a client base, generating very little volume. therefore how do they survive? are they not required to resort to trading against their clients? my guess is that the other side of their business (futures, options, securities) is probably used to prop up the FX side. Interactive Brokers probably used to do the same as well since they were well established for decades before catering to FX retail traders and therefore the losses incurred initially by the latter division were offset by the profits generated by the other, more established, divisions of the company.
take-away #4: there is no technological unfeasibility anymore to integrating the retail and institutional OTC markets.
why is the OTC FX market still so fragmented? and especially the divide between institutional players vs retail traders as if it were set in stone does not make any sense any longer.
also, take a look at this chart here: Portware FX and browse their site. you'll start getting an idea for what is possible.
and this about FX aggregation: FX Aggregation, Forex Trading Platforms | Progress Software
listen to this for general 'behind the curtain' FX education: FX traders push for greater transparency into execution processes and costs | ITG
here is HotspotFX, Knight Hotspot FX, which used to be available for retail traders, but now only for institutionals--the screen shot of the UI will give you a better idea of the order entry platforms professionals use--note that each pair has a DOM (Depth of Market) displayed as well with volume at each price point.
algo trading tech for the big guys--very impressive:
ALGO Technologies unveils ALGO M2 exchange/MTF matching engine : Automated Trader
and algo trading for the rest of us: https://www.quantopian.com/
so my personal conclusions would be (and please feel free to correct any points that are mistaken) but at this point this is the advice i am giving myself, and perhaps it might be helpful to the greenhorn trader just starting out with high hopes:
- use professional grade client order management software --> MT4/MT5 isn't it
- use professional charting software --> again, MT4/MT5 isn't it
- currently, these 2 functions are more and more integrated into one software package and many brokers/dealers, if they don't provide it for free, will allow a client to hook up to their order servers and sometimes quote servers as well (data feed): since some may ask, here it is (and this is not a recommendation, just listing what i know is available in no particular order of preference, but which is more solid and professional that this PoS MT4/MT5): Multicharts, eSignal, CQG, CTS, TradeNavigator, VT Trader (client side app for charting and order placement), and am sure there are lots more but since i haven't heard about them…
- when in doubt, ask your broker/dealer to confirm your trade(s) with a trade receipt direct from their liquidity providers: they all get such a receipt and traders have a right to see it as well as a right to know how their orders are routed (there is something mentioned about this somewhere on the SEC site, i think, or was it the CFTC? i can't remember at this moment.)
- as to the broker:
1- find one that has a lot of retail volume if you are going to trade in sizes less than 1 standard lot (< 100K of base currency) and that can prove that the order execution will go through an ECN/EXN without any virtual dealer intervention. that's why you need volume. if the volume just isn't there, then who are you going to trade your tiny order against? against a market maker, which will act as the counterpart of last resort in this case (but again, if this model is totally accounted for in the broker/dealer cost structure, they don't have to cheat you, but you won't know until you actually put some money down, i guess, or persistently ask to have them give you a clear break down in writing of how the orders are routed and matched). or the trade matching engine will simply reject the order until either (1) a counter party match is found, or (2) you increase your order size.
2- assuming that you become a profitable trader, your account will grow until you will reach a point where you can trade sizes beyond 1M in one click. at this point, you gotta ask yourself: does my broker's ECN/EXN allow my trade to be matched fully against orders coming in from other ECNs, institutional players and so on (as explained above)? if no, then you might run into a max order size limit because the brokers 'local' ECN/EXN doesn't have the volume to absorb your order(s), which reminds me of something interesting i read on the Interactive Brokers site: they say that a SPOT FX order size cannot exceed 5M max. i thought that's interesting considering that Interactive Brokers is supposed to be this huge company. if they limit client order size to a maximum of 5M, which is puny, then what does that tell you not only about Interactive Brokers, but also about the other brokers/dealers out there who are much smaller in market size? to get back to the point, when your account size has grown to the 1M and beyond mark, then comes the time to consider who can provide lightning fast execution and fills for larger order sizes? answer: prime brokers. so you have the established prime brokers, and the new kids on the block, companies that started out as RFEDs and are now also offering services to the institutional market (GAIN Capital GTX, FXCMPro, MBT Institutional, Dukascopy Bank SA, and probably a few more). but that's for another time.
good luck and good trading.
PS: just came across this old post on the FPA broker review from a user in London; i'm reposting here because it contains some valuable info IMHO (Currenex Reviews | Currenex Ratings | currenex.com reviews and ratings)
'I have read all of the reviews here on Currenex and there are some absolutely correct understandings of the system and brokers etc but also some absolute rubbish and misinformed nonsense so I thought I would try and set the record straight....
Currenex is a software vendor. In order to gain access to Currenex you need a broker to hold your account. Currenex does not have any direct relationships with the liquidity providers or brokers except as a vendor of software, therefor the broker you choose will dictate what terms of business you are on and what pricing you see.
Not all brokers have the same pricing on their versions of currenex as each other, why? Firstly the broker might only have relationships with a few banks, obviously the more banks the better the spread and the deeper the liquidity (theoretically). Secondly, the broker might not be well capitalised and therefore in order to gain access to all the liquidity providers they inturn will use a prime broker. Some of the companies mentioned here do that. Obviously this puts up the fees. Finally, the broker might have many liquidity providers and his credit is fine but the liquidity providers dont like the flow from that brokers clients and therfore the stream a wider price.
So as you can see there are three main reasons as to why the pricing on currenex can be different from broker to broker. In my opinion when choosing a broker you have to consider the following how big is the broker what balance sheet, the smaller they are the more costs there will be and they will have to pass those costs on.
So as you can see above we have looked at the relationship between the Vendor Currenex The brokers and the liquidity providers. Lets now look at the brokers themselves.....So as you can see can the brokers be subjected to different pricing for all the above reasons you then have to factor in what the brokers offer publically in terms of their margin reates and $/per million fees and what they choose what not to tell you.
What they all tell you is their margin rate is 1%,2%, 3% or more and that is dependent on their own credit and risk policies. As you will see if you just make a few phone calls yourselves the larger institutions are more conservative with their margin rates and the smaller capitalised companies offer more aggressive margin rates. If you are highly leveraged then the decision is simple you can only go to a smaller company to get the bang for your buck. If you don't leverage and you are more conservative in your own risk management then the level of margin you pay is a mute point.
In addition the $/per million fee. As above if you are trading with a smaller company that has a prime broker and other people to pay then the fee will be higher. One of the people below mentioned $50 per million.This is criminal. Anyhing above $15 per million is the wrong number and for volume single figures is achievable.
What they don't tell you.....spreading the prices....Did you know that if the price the broker gets from the liquidity providers is less than 1 pip (which it often is, at the time of writing the price I see from my provider is 1.41764/770) They can widen the price a keep the difference. Did you also know that they can also choose for the trade to hit their book rather than allowing it to offset direct with the liquidity provider. And as some one else in this forum suggested they can choose weather they allow the clients prices to match off against each other or not.
So all is not what it seems eh! The brokers have different prices from each other different terms of business and are able to manipulate almost every part of the process. No change there then and those that have suggested its a level playing field need to get their heads out of the sand. I saw someone moaning about the slippage on the platform over numbers and with stop loss order, geez fella get a life!!! what you forget that these positions end up on real peoples desks at the liquidity providers and they have to manage them, so over numbers and in times of volatility the machines don't work.
Currenex is not a matching engine it is not EBS.
That said if you choose the right broker i.e. a larger one tyha doesnt need an prime broker and doesn't widen the prices and offers low $/per million then your off to the races the technology is fantastic and I use it everyday.'
k guys, everything you are gonna read in this post is in no way meant to recommend or endorse this product or company against another one and so on. also, as i am performing some due diligence in my search for the next trading venue, this is a snapshot of all the info i came across, and as such, i suddenly realized that maybe this could be helpful to newbies who are just starting out. god knows i wish someone had told me all this when i started out. anyway, whatever conclusions i put forth are solely my own, etc… and since i do not know everything, i am sure i must be mistaken on quite a few things. so the more experienced traders out there reading this, by all means, please correct me where necessary.NOTE: just attached 1 more PDF, explains what goes in a data stream, interesting inside look even if superficial.
ok that being said, let's consider first some terminology: ECN can mean 'Electronic Communication Network' or 'Electronic Crossing Network'. MB Trading calls the latter an EXN. go on wikipedia and look it up: Crossing network - Wikipedia, the free encyclopedia .
also lookup ATS, which is called MTF in Europe (LMAX is an example of a European MTF on which one can trade SPOT FX and CFDs, just recently opened by Betfair, one of the largest betting exchanges in the world)--[ UPDATE: Betfair recently sold LMAX through a MBO (Management Buyout): http://forexmagnates.com/lmax-gets-sold-to-management-valued-at-3-6-million/ ], and ECN, which is a subset of ATS (in the US). follow the external links. go to the institutional service provider websites and read the literature and you'll get a sense of where the technology is at today and what is possible. hint: all the retail pools at all these RFEDs and retail ECNs can all be aggregated and put out there on a marketplace platform where both the orders from the institutionals and the retail traders can be matched up once the matching engine algorithms breaks them down properly.
also, read about 'dark liquidity' here:Dark liquidity - Wikipedia, the free encyclopedia as it will highlight some important points pertaining to the whole price discovery mechanics and order matching.
then this: Pipeline Settles With U.S. SEC Over Dark Pool Claims - Bloomberg
and even though the former concerns the equity market, and the order sizes are orders of magnitude larger than in the retail FX market, it illustrates a similar principle at work, no matter the scale. especially pay attention to this paragraph:
'The problem Pipeline faced, the difficulty in matching blocks when investors want to trade, is one many operators of dark pools deal with as they build their venues and seek more orders. Brokers running dark pools often address this by enabling a stream of orders from their own firm’s market-making units or by allowing outside automated traders or high-frequency firms to fill that role within their system, Tabb said.'
and so, if the big guys do it…. you get the picture.
now let's take a look at how bad it can really get and how good it could be, and in-between.
take-away #1: let's say you're a small retail trader and your orders are small, meaning some fraction of a standard lot (which is equivalent to 100K base currency units in the market). from what i understand by looking at the institutional trading platforms and searching the web, the real market, that is, the prime brokers, the banks, the hedge funds, corporates, high net worth investors, retail brokers/dealers exporting their retail liquidity pool, that is, the liquidity aggregated from all their retail clients' orders (the ones large enough such as FXCM, GAIN Capital, Interactive Brokers, Dukascopy Bank SA to name a few) and so on, will not be your counterpart if you buy, for ex., less than 10 lots of eur/usd. anything less than 1M is too small. on institutional platforms standard order sizes are preset to 1M, 5M, 10M, 15M, 20M, 25M, sometimes 50M. actually the order size buttons can be configured to whatever the institutional trader wants, so it could even be 100M.
now, what does this mean for the execution of the retail trade? it means that:
1- if the broker/dealer has enough retail clients trading at the same time you are trading (that is, there is sufficient liquidity available on your broker/dealer order book on their network, not the order book sitting on another network belonging to another broker/dealer), then they can match your order against the order of another of their retail client (that's what a ECN=EXN Electronic Crossing Network means), but it does not mean they do it--some do and some don't;
2- so, if the broker/dealer does not have enough retail clients trading at the same time you are trading, and thus volume/liquidity is way down in the market or marketplace they are creating for their retail clients, then you might not find another retail trader counterpart at the price point you want; and since you order is too small to offload into the institutional market, the broker/dealer only has 2 choices at that point: take the other side of the trade, or let the trade slip until it can be matched to another client order on the book. but since every broker/dealer out there is making a point in their marketing literature of telling us that there is no or very little slippage because the FX market is so huge (yes, the real (institutional) FX market is huge, but it doesn't matter at the order size retail traders play with because in case (2) we do not get access to it because our orders are too small, especially the minis and micros), they will try to execute your order as quickly as possible and to do so in a situation of low liquidity, it can only be done if the broker/dealer takes the other side of the client's trade. and now we have potential conflict of interest. (more about this in a sec.)
3- but if the broker/dealer has a good technological infrastructure, say for example, they are hooked into Integral (an FX aggregator), or Currenex, or FXAll, or LavaFX, or HotSpotFXi, or Portware, and so on, and if their business model is not to engage in proprietary trading against their client base, then as in case (2) above, they still can be the counterpart to a client's trade but only as a middleman passing the client's trade along to be matched to another order coming in from the various aggregators i mentioned, thereby limiting their risk exposure and thus obviating the need for them to trade against the clients because they have access to so much liquidity now that it is no problem filling all the small orders coming from their retail client base. in this case, the broker/dealer does not need to be a market maker any longer as in case (2).
in this regard, i think brokers/dealers have to be in the middle as a counterpart (and not necessarily as a market maker) for clearing/settlement purposes because after they inject their clients aggregated orders into the 'real' market, once those orders need to be settled, they will not be settled retail trader by retail trader versus whatever entity took the other side in the real market. in other words, when the retail orders go out in the real market (because the broker/dealer is the one who gets the line of credit from some prime brokerage or bank(s) and extends that credit (as leverage) to the retail client), the other institutional participants will see volume coming from your broker/dealer marked with that broker/dealer ID and not 100s or 1,000s of retail orders each marked with a retail trader's ID.
BUT, and this is a big BUT, just because a broker/dealer seems to fit in case (3) DOES NOT mean that they are not engaging in proprietary trading against their client base. case in point, GAIN Capital--here is what i found on the NFA site, and bear in mind, that in the case of GAIN it was not only the retail clients who were affected, but also the institutional clients:
'On October 27, 2010, NFA's BCC issued a Decision accepting an Offer of Settlement submitted by Gain and Stevens, in which Gain and Stevens neither admitted nor denied the allegations of the Complaint and agreed to settle the case on the following terms: Gain agreed to refund to customers the amount of negative slippage they experienced on the trades that were placed in their accounts between May 1 and July 31, 2009 and which were attributable to the Virtual Dealer Plug-in that Gain used on its institutional and retail servers….'
read the last sentence one more time--a light bulb should go off at this point. a virtual dealer (i.e. deal desk) plug-in used on both the institutional and retail servers.
take-away #2: whether you are a small fish or a big one, if the crooks want your money, they'll try no matter who you are.
take-away #3: no matter who your broker/dealer is, they have the technological means to totally control everything about the price feed clients receive.
as an example of how easy it is for brokers/dealers to do whatever the f%&* they want with the feeds, take a look at the attached screenshot of the admin interface ProTrader/PFSoft provides to brokers/dealers. you can clearly see in the General Settings pane 2 entry fields: one is to set the maximum spike value and the other the minimum spike value: http://pfsoft.com/sites/default/files/pages_galleries/backoffice_1.png
the other URL to their back office software: Discover the world of Protrader | PFSOFT (PFsoft provides a trading platform for brokers/dealers as well as front-end software brokers/dealers will make available for free to the retail customers (parts of the MBTrading client software MBTDesktop and MBTDesktop Pro is built on top of the PFSoft API, if i am not mistaken).
and a better illustration comes from the Visual Trading Systems website, where the company explains what the VT Dealer can do for the brokers/dealers:
VT Dealer | Visual Trading Systems
and a nice logical network map here: VT Spot? Platform | Visual Trading Systems
the few firms that are honest about this will have proprietary cash set aside just for the purposes of trading against their clients, which helps them absorb the losses on those small trades when a minority of their clients are right. it's part of their cost structure. but those companies who have a different cost structure that does not involve eating the losses if their clients's trades are in-the-money, will cheat to get out of the trade at a more favorable price (undue margin calls, spikes, etc).
that being said, here is what i found from GAIN Capital's FORM 10-Q SEC filing (also attached) for the quarterly period ended 30 September 2012, and to their credit, they are at least transparent insofar they admit publicly how the game is going to be played if you step down into the arena with them (i wish the same could be said of the rest of the RFEDs and brokers out there, but sadly not, as they all still cultivate an artful marketing fog):
'UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
GAIN CAPITAL HOLDINGS, INC
We do not take proprietary directional positions to mitigate our exposure to changes in foreign currency exchange rates.
We generate retail trading revenue as follows:
• for trades that are naturally hedged against an offsetting trade from another customer, we receive the entire retail bid/offer spread we offer our customers on the two offsetting transactions;
• for trades that are hedged with one of our wholesale forex trading partners, we receive the difference between the retail bid/offer spread we offer our customers and the wholesale bid/offer spread we receive from the wholesale forex trading partners; and
• with respect to the remaining customer trades, which we refer to as our net exposure, we receive the net gains or losses generated through changes in the market value of the currencies held.
Market Risk
We are exposed to market risk in connection with our retail trading activities. Because we act as counterparty to our retail customers’ transactions, we are exposed to risk on each trade that the market price of our position will decline. Accordingly, accurate and efficient management of our net exposure is a high priority, and as such we have developed both automated and manual policies and procedures to manage our exposure. (<-- it is these procedures that got GAIN in trouble with the NFA)
These risk-management policies and procedures are established and reviewed regularly by the Risk Committee of our Board of Directors. Our risk-management policies require quantitative analyses by currency pair, as well as assessment of a range of market inputs, including trade size, dealing rate, customer margin and market liquidity. Our risk-management procedures require our team of senior traders to monitor risk exposure on a continuous basis and update senior management both informally over the course of the trading day and formally through intraday and end of day reporting. A key component of our approach to managing market risk is that we do not take proprietary directional market positions and therefore do not initiate market positions for our own account in anticipation of future movements in the relative prices of the products we offer. To facilitate our risk-management activities, we maintain levels of capital in excess of those currently required under applicable regulations. As of September 30, 2012, we maintained capital levels of $100.7 million, across all of our regulated subsidiaries, which represented approximately 2.4 times the capital we were required to hold.'
please note that the phrase 'we act as counterparty' does not necessarily entail that the broker/dealer is trading against you, as explained in case (3) above. here is some info in that regard i found on Advanced Markets FX site: http://www.advancedmarketsfx.com/tr_NFA01.htm .
here is the best summary i have been able to find online so far re the mechanics of trading retail. this is from the Dukascopy Bank SA FAQ page where we can read (FAQ :: Dukascopy Bank SA | Swiss Forex Bank | ECN Broker | Managed accounts | Swiss FX trading platform):
'Can Dukascopy Bank SA be the counterparty of my trades?
Notwithstanding the fact that the SWFX – Swiss FX Marketplace is an ECN, Dukascopy Bank SA is the counterparty of all of its clients’ trades. Dukascopy Bank SA sends orders to the interbank market in its own name for hedging purposes. Not all clients’ trades necessarily result in orders sent straight to the interbank by Dukascopy Bank SA. The small size of a trade may have an incidence on the ability of Dukascopy Bank SA to hedge it with its counterparties since the latter may not accept trades under a certain minimum size. Therefore, Dukascopy Bank SA may be obliged to cumulate a certain number of executed trades prior to being able to hedge them in the market. However this depends on hedging counterparties’ minimal lot size and current exposure of already cumulated trades. All traders receive the same data feed and same execution quality whatever the size of their trades.'
also on Dukascopy's site i found this regarding execution (sorry i misplaced the URL):
'Execution
Dukascopy Bank SA has a unique technology to hedge instantly any clients' trades directly with other Liquidity Providers.'
and i like this explanation from Dukascopy Bank SA: on this page they talk about liquidity a little--very interesting, apparently their platform can absorb up 2,000 lots (i think they say it's USD$ 200M) in one click with no significant delays but spread goes up to 4-5 pips as, i guess, the platform is trying to breaking down the order to match it on the ECN--but that's some decent liquidity: SWFX Swiss FX Marketplace Solution :: Dukascopy Bank SA | Swiss Forex Bank | ECN Broker | Managed accounts | Swiss FX trading platform . for comparison, when you go to the Currenex site, scroll further down that page and click on JFX: here is the link i went to, JFX Liquidity - JFX.com - Forex Trading; on this page you will find this: 'Liquidity pool up to $500 million'.
interestingly, FXCMPro is also listed on that page as a white label partner. and what is even more interesting is that Barclays retail FX trading service is an FXCM white label! that is, they use the same software for the client: Trading Station, MarketScope, and the orders are routed through FXCM. i fail to see then what's the advantage of opening an account with Barclays.
anyways, at the end of the day, the problem we, as retail traders face is one of size (being too small) and liquidity, that is to say, if you are too small and there aren't enough other small sized retail orders on the same ECN/marketplace with your order, then how does your order get filled if the broker/dealer doesn't play market maker?
therefore the more volume a broker/dealer can attract, the better for the bottom line and the better for the retail clients as the RFED can now improve its balance sheet, which in turn helps get a larger credit line from the prime broker(s) it needs to gain access to the real/institutional/interbank market, also helps get better pricing (spreads) that can be passed on to the retail clients, and improved liquidity. that is perhaps why in the early days, when most of the RFEDs were not large enough in terms of retail volume to have a sustainable business, they had to resort to shady practices in order to grow the business and survive long enough until they became able to switch to practices that, although initially not sustainable, had now become sustainable. (not trying to excuse anything here, just thinking out loud).
some people might now point out that MB Trading has too small a client base, generating very little volume. therefore how do they survive? are they not required to resort to trading against their clients? my guess is that the other side of their business (futures, options, securities) is probably used to prop up the FX side. Interactive Brokers probably used to do the same as well since they were well established for decades before catering to FX retail traders and therefore the losses incurred initially by the latter division were offset by the profits generated by the other, more established, divisions of the company.
take-away #4: there is no technological unfeasibility anymore to integrating the retail and institutional OTC markets.
why is the OTC FX market still so fragmented? and especially the divide between institutional players vs retail traders as if it were set in stone does not make any sense any longer.
also, take a look at this chart here: Portware FX and browse their site. you'll start getting an idea for what is possible.
and this about FX aggregation: FX Aggregation, Forex Trading Platforms | Progress Software
listen to this for general 'behind the curtain' FX education: FX traders push for greater transparency into execution processes and costs | ITG
here is HotspotFX, Knight Hotspot FX, which used to be available for retail traders, but now only for institutionals--the screen shot of the UI will give you a better idea of the order entry platforms professionals use--note that each pair has a DOM (Depth of Market) displayed as well with volume at each price point.
algo trading tech for the big guys--very impressive:
ALGO Technologies unveils ALGO M2 exchange/MTF matching engine : Automated Trader
and algo trading for the rest of us: https://www.quantopian.com/
so my personal conclusions would be (and please feel free to correct any points that are mistaken) but at this point this is the advice i am giving myself, and perhaps it might be helpful to the greenhorn trader just starting out with high hopes:
- use professional grade client order management software --> MT4/MT5 isn't it
- use professional charting software --> again, MT4/MT5 isn't it
- currently, these 2 functions are more and more integrated into one software package and many brokers/dealers, if they don't provide it for free, will allow a client to hook up to their order servers and sometimes quote servers as well (data feed): since some may ask, here it is (and this is not a recommendation, just listing what i know is available in no particular order of preference, but which is more solid and professional that this PoS MT4/MT5): Multicharts, eSignal, CQG, CTS, TradeNavigator, VT Trader (client side app for charting and order placement), and am sure there are lots more but since i haven't heard about them…
- when in doubt, ask your broker/dealer to confirm your trade(s) with a trade receipt direct from their liquidity providers: they all get such a receipt and traders have a right to see it as well as a right to know how their orders are routed (there is something mentioned about this somewhere on the SEC site, i think, or was it the CFTC? i can't remember at this moment.)
- as to the broker:
1- find one that has a lot of retail volume if you are going to trade in sizes less than 1 standard lot (< 100K of base currency) and that can prove that the order execution will go through an ECN/EXN without any virtual dealer intervention. that's why you need volume. if the volume just isn't there, then who are you going to trade your tiny order against? against a market maker, which will act as the counterpart of last resort in this case (but again, if this model is totally accounted for in the broker/dealer cost structure, they don't have to cheat you, but you won't know until you actually put some money down, i guess, or persistently ask to have them give you a clear break down in writing of how the orders are routed and matched). or the trade matching engine will simply reject the order until either (1) a counter party match is found, or (2) you increase your order size.
2- assuming that you become a profitable trader, your account will grow until you will reach a point where you can trade sizes beyond 1M in one click. at this point, you gotta ask yourself: does my broker's ECN/EXN allow my trade to be matched fully against orders coming in from other ECNs, institutional players and so on (as explained above)? if no, then you might run into a max order size limit because the brokers 'local' ECN/EXN doesn't have the volume to absorb your order(s), which reminds me of something interesting i read on the Interactive Brokers site: they say that a SPOT FX order size cannot exceed 5M max. i thought that's interesting considering that Interactive Brokers is supposed to be this huge company. if they limit client order size to a maximum of 5M, which is puny, then what does that tell you not only about Interactive Brokers, but also about the other brokers/dealers out there who are much smaller in market size? to get back to the point, when your account size has grown to the 1M and beyond mark, then comes the time to consider who can provide lightning fast execution and fills for larger order sizes? answer: prime brokers. so you have the established prime brokers, and the new kids on the block, companies that started out as RFEDs and are now also offering services to the institutional market (GAIN Capital GTX, FXCMPro, MBT Institutional, Dukascopy Bank SA, and probably a few more). but that's for another time.
good luck and good trading.
PS: just came across this old post on the FPA broker review from a user in London; i'm reposting here because it contains some valuable info IMHO (Currenex Reviews | Currenex Ratings | currenex.com reviews and ratings)
'I have read all of the reviews here on Currenex and there are some absolutely correct understandings of the system and brokers etc but also some absolute rubbish and misinformed nonsense so I thought I would try and set the record straight....
Currenex is a software vendor. In order to gain access to Currenex you need a broker to hold your account. Currenex does not have any direct relationships with the liquidity providers or brokers except as a vendor of software, therefor the broker you choose will dictate what terms of business you are on and what pricing you see.
Not all brokers have the same pricing on their versions of currenex as each other, why? Firstly the broker might only have relationships with a few banks, obviously the more banks the better the spread and the deeper the liquidity (theoretically). Secondly, the broker might not be well capitalised and therefore in order to gain access to all the liquidity providers they inturn will use a prime broker. Some of the companies mentioned here do that. Obviously this puts up the fees. Finally, the broker might have many liquidity providers and his credit is fine but the liquidity providers dont like the flow from that brokers clients and therfore the stream a wider price.
So as you can see there are three main reasons as to why the pricing on currenex can be different from broker to broker. In my opinion when choosing a broker you have to consider the following how big is the broker what balance sheet, the smaller they are the more costs there will be and they will have to pass those costs on.
So as you can see above we have looked at the relationship between the Vendor Currenex The brokers and the liquidity providers. Lets now look at the brokers themselves.....So as you can see can the brokers be subjected to different pricing for all the above reasons you then have to factor in what the brokers offer publically in terms of their margin reates and $/per million fees and what they choose what not to tell you.
What they all tell you is their margin rate is 1%,2%, 3% or more and that is dependent on their own credit and risk policies. As you will see if you just make a few phone calls yourselves the larger institutions are more conservative with their margin rates and the smaller capitalised companies offer more aggressive margin rates. If you are highly leveraged then the decision is simple you can only go to a smaller company to get the bang for your buck. If you don't leverage and you are more conservative in your own risk management then the level of margin you pay is a mute point.
In addition the $/per million fee. As above if you are trading with a smaller company that has a prime broker and other people to pay then the fee will be higher. One of the people below mentioned $50 per million.This is criminal. Anyhing above $15 per million is the wrong number and for volume single figures is achievable.
What they don't tell you.....spreading the prices....Did you know that if the price the broker gets from the liquidity providers is less than 1 pip (which it often is, at the time of writing the price I see from my provider is 1.41764/770) They can widen the price a keep the difference. Did you also know that they can also choose for the trade to hit their book rather than allowing it to offset direct with the liquidity provider. And as some one else in this forum suggested they can choose weather they allow the clients prices to match off against each other or not.
So all is not what it seems eh! The brokers have different prices from each other different terms of business and are able to manipulate almost every part of the process. No change there then and those that have suggested its a level playing field need to get their heads out of the sand. I saw someone moaning about the slippage on the platform over numbers and with stop loss order, geez fella get a life!!! what you forget that these positions end up on real peoples desks at the liquidity providers and they have to manage them, so over numbers and in times of volatility the machines don't work.
Currenex is not a matching engine it is not EBS.
That said if you choose the right broker i.e. a larger one tyha doesnt need an prime broker and doesn't widen the prices and offers low $/per million then your off to the races the technology is fantastic and I use it everyday.'
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