This article follows on the Forex Broker Introduction available here
Forex broker's interests
Unfortunately in forex trading their is a clash of interests between the forex broker and its clients in a direct sense not applicable to many other consumer businesses and industries.
For instance while a cellphone operator would love all their clients to use more talktime and data they cannot offer "training" on "how to use your cellphone", disguised as a way to get you to spend more.
In online forex trading, which is also a faceless mass market, it works different and it is dangerous for prospective forex traders.
The forex brokers' interests are as follows:
- Signup as many forex trading clients as possible
- Teach them about fast paced, high leveraged trading
- Get them to fund a live trading account as soon as possible
- Get them to begin to trade as soon as possible
- Get them to do bigger trades more regularly
- When their accounts are depleted, get them to refund
- Repeat and expand this approximately six week cycle ...
Do forex brokers trade against their clients?
Forex brokers are not charitable organizations. Like other businesses they are there to make money for the owners, pay their children's private school fees, their French riviera holidays, their Ferrari's, their wife's mink coats and designer shoes, the Rolexes and other banalities.
The ideal for any forex broker is to have thousands and thousands of clients who trade very regularly and are consistently successful in their trading. The reason is the competitiveness of the online forex trading industry. To acquire customers are expensive. To see them leave for a competitor, tragic.
There is an Internet meme that forex brokers "trade against" their clients in a way that is bad for the clients and as if this is the reason for most client losses.
The fact that a forex broker is a market maker and thus the counter party of its client and buys from or sells to the client isn't inherently negative for the client.
In fact, there must be a counter party who takes the trade and who will either win or lose depending on if the trader makes a profit or loss with the trade.
Therefore even though a No Dealing Desk / ECN broker passes the trade on to a liquidity provider, the client's broker he had signed a contract with and with whom he subsequently had deposited his margin is the counter party of his trades.
They must pay you if you make money. Where they get the money is their problem, not yours!
Today many brokers offer both Dealing desk and ECN trading accounts and the client has a choice. Another development is that many DD brokers have most of the time automated dealing and there is indeed no physical intervention by a human. But they have the ability to put the whole system or specific accounts on "manual dealing" or for big transactions or to discourage what they in terms of the agreement might perceive as abusive trading tactics or undue risky trading tactics.
The difference is that the NDD broker have limited or no means to manipulate prices while the market maker has that ability.
|| Price manipulation is something different from the fact that as your contractual counterparty your broker "lose" if you "win".
Price manipulation is problematic and is possible with the available dealingroom software and an unscrupulous dealer. Especially for so-called scalpers or traders who use very high leverage to gain only a few pips in a few seconds or minute or two. The question is if a market maker is the best counterparty for such traders.
Both the US and Australian regulators have acted against firms because of price manipulation and it is generally accepted that well regulated firms of high quality and enough trading volume have no need to entertain price manipulation at the cost of client relationships and the brand's good name.
This might be different for smaller firms with lower trading volumes (few clients) in unregulated environments.
Not all trading styles are "born equal" - atleast from the point of view of a forex broker.
Below is an excerpt from the T & C's of a well known large forex broker.
It refers to "abusive practices" by clients and a lot of the abuse market makers had to take over years had to do with the fact that traders tried to game the cordial relationship that could exist in fair market making and fair trading by exploiting "weaknesses" in the forex broking / market making process.
Forex brokers don't look kindly on that and contractually they reserve rights to prevent that temporarily or permanently.
|Trading strategies aimed at exploiting errors in prices
(commonly known as “sniping”) are not accepted by BROKER. If BROKER, at its sole discretion in good faith, determines
that Client is taking advantage or attempting to
take advantage of such misquotes or is performing other
forms of abusive trading, BROKER is entitled to take
one or more of the following countermeasures:
- Adjust the price spreads available to the Client;
- Restrict the Client’s access to streaming, instantly
tradable quotes, including providing manual quotation
- Retrieve from the Client’s account any historic trading
profits that have been gained through such abuse of
liquidity – as determined by BROKER in its sole discretion
in good faith – at any time during the client
- Terminate the client relationship immediately by giving
From Market Makers to Marketing Maestros
To be a good broker you must be able to lie consistently
Terry Smith – renegade broker
The forex broker business model is trading volume dependent. Most accounts are relatively small trading mini and micro lots. Forex brokers must therefore not only sign up many clients but must also promote high volume trading by those clients.
That is the primary conflict of interest between forex brokers and forex traders.
High volume trading on small accounts can be achieved by offering almighty high leverage levels (up to 500:1 is common these days) and promoting high frequency intra day trading.
In order to get clients to conform to the high volume trading model brokers do (amongst others) the following:
- Under play the destructive effect of too high leverage. I.e. traders don't realize what incredibly high risks they are taking with their margin capital.
- Cultivate a gambling mindset amongst beginner traders by glorifying high leveraged intra day trading.
- Offer competitions and prizes for very short term trading competitions of which the winners are just lucky. This is then promoted as skills that anyone can acquire.
- Offer bonuses for account deposits but the T&C's of the bonus involves extremely high volume trading if the trader ever wants to really benefit from it.
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