Last month we published an interview that did a lot to reveal the underbelly of the Forex industry. In short, it spelled out in plain terms how the big Forex brokers that came to the forefront after 2008 made their money, and how they grew essentially on the backs of their clients. By re-quoting, slowing down execution and withholding client money, they did what was very easy during a time when clients didn’t have enough knowledge about the business, and when oversight was non-existent.

It’s what’s causing a renaissance in Forex now. And the bad history is giving way to new Forex startups that want to break with the old ways and give clients a level playing field.

But not everything beneath the surface is changing for the better.

From Dealing Desks to Electronic Execution
The electronic revolution in Forex was a reaction to the poor practices of old brokers who utilised dealing desks with human dealers working around the clock to “process” client trades. When we say “process,” we mean, “make sure the trades clients are executing are not making money”.

This was an inherently messy process; you had thousands of trade requests per day that had to be analysed on the fly by dealers and re-quoted or slowed down to prevent “bad traders” from gaming the broker. This meant that even “good traders” (the losing ones) had their execution slowed down just because of the sheer inefficiency of what was going on. This doesn’t even touch on the customer support aspect of trying to explain away all of the shady things the dealing desk was doing.

Instead of dealing desks with human dealers, new brokers touting “electronic execution” and “no dealing desk” just created new dealers in electronic form.

Enter the “ECN” broker.

In the Forex world, the term “ECN” is a nebulous and varying concept. In truth, it is “an automated system that matches buy and sell orders for securities” as defined by Investopedia. It is an alternative to the market maker system in which a middleman passes trades between two parties. In today’s reality, “ECN” is nothing but a marketing term designed to communicate to traders that (a) they will pay a commission in return for a lower spread and (b) the broker generally will use “market execution” and have better terms than other accounts.

There is nothing guaranteeing which venue your trades will be executed. In fact, ECN accounts are just as likely to have your broker as the middleman or as the only counterparty taking the other side of your trade.

A major Forex broker provides a graphic on their website similar to this one when describing their execution method:

What they are really doing is more like this:

What’s going on is the prices clients see in their trading platform are actually ECN prices transmitted from liquidity providers, but by utilizing a liquidity bridge, the broker is able to choose which trades they send back to the liquidity provider (prime broker) and which trades they execute internally (make the market).

Now, by itself, there isn’t anything wrong with the broker being the counterparty. It’s how your broker reacts when your trades are profitable and causing the broker to lose money or you are scalping with a very high execution speed. With clients who are utilising scalping strategies it becomes very obvious to them very quickly that their trades are being delayed.

So because of this conflict of interest where the broker is still dependent on losing clients, an “ECN” broker without any ability to manage its own risk is just a dealing desk in disguise. Instead of dealing desks with human dealers, new brokers touting “electronic execution” and “no dealing desk” just created new dealers in electronic form.

Why can’t I just go to a bigger broker? Or use a “prime broker” that’s too big to care if I’m losing?

That’s probably a question you’re asking yourself now that you know every ECN broker has their hands on your trades. But the nature of the Forex market is one that necessitates market makers, because the currency market is one without a central exchange, and one that is too big to ever be on one exchange.

That is why even the prime brokers that are serving retail brokers are just bigger versions of retail brokers. Prime brokers, brokers with minimum account balances in the hundreds of thousands of dollars and minimum lots sizes of millions of units of currency, are just as likely to be market makers.

Even the prime brokers are just bigger version of retail brokers. Prime brokers are just as likely to be market makers.

So where do I go? How do I get better execution on my trades and fair treatment?
The decentralised nature of the currency market makes it extremely complex. What you have, essentially, are counterparties of varying scopes and sizes trading between each other in an almost infinite web. The only differences in them are the levels of access they provide, i.e. how big of an account and trade size they require from their clients.

So you might be thinking to yourself, “I should be trying to get an account with that huge broker that provides interbank pricing”. Well, you could. But now you are tied to what is essentially a large market maker who is concerned with generating revenue from commissions or spreads on large trade sizes. Again, you are no more likely to get faster execution or lower spreads 100% of the time.

As a client, if your true concern was to receive the best spreads and execution 100% of the time, you would have to open multiple trading accounts at different prime and retail brokerages and trade on all of them. Can you imagine having open one mini-lot of EUR/USD on one broker’s platform and having to close the trade on another because their spreads went lower?

The Hybrid Brokerage and Client Focused Trading
Keeping that chaotic example in mind, what should a Forex brokerage’s goal be if they wanted to give their clients the best prices and terms 100% of the time?

The client is what makes up the entire base of the financial industry, not just the Forex market. As we illustrated in the Forex Web graphic previously, clients of all different sizes is where the web begins. There wouldn’t be any reason for the banks to exist if some client didn’t have a reason to place a trade, whether they are trading for business purposes or for speculation.

This means that a client should not have to have more than one account at a respectable brokerage, no matter the size of the broker. The main concern for the broker should be being the bridge to the many different execution venues available in the entire market, and passing the client’s trades to whoever is the best at that given moment, or more simply, connecting the individual client to the Forex Web.

It shouldn’t matter that your broker isn’t making the most money it can off of your trades. A hybrid model brokerage’s main concern is putting the technology in place to connect multiple sources of prices and liquidity to the client’s trading platform.

Whether the broker takes the other side of the trade or the liquidity provider does is an afterthought for the client. In many ways, the broker is in the same shoes as the client when it comes to taking positions in the market; they must decide too how they offset risk and prevent losses.

Excellent examples of brokerages only utilising ECN execution who failed miserably are Alpari UK and FXCM during the Swiss Franc crisis. The former went into insolvency and the latter needed a bailout in order to avoid insolvency.

This is all because they were inflexible with their risk-offset policies and were left with huge liabilities when client accounts went negative.

In the future, the focus on wringing out as much profit from clients is likely to fade, given the fact that there is so much competition in the retail Forex space. The condition of having the best prices and trading terms should be an afterthought, and the broker will instead focus more on selling ancillary services to clients and branching out into other finance businesses.

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