Monday, December 7, 2009

The Riddle of Forex Brokers

Forex (Foreign Currency Exchange) traders spend a lot of time worrying and talking about their various concerns about the retail brokers they engage to handle their trades. The prevailing assumption is that whenever you attempt to make money in forex you are plying your talent against 'the market' and that's the only competition you should be thinking about. In truth, there is so much more to it; the broker who is honoring your trades can strongly impact your ability to make money.

Bucketshops are agencies who take unfair advantage of their traders by working against them and often by changing the prices they give. Very few agencies will own up to acting this way, mainly because it gives them a powerful incentive to cause their clients to lose. Another phrase often used for such companies is 'Market Makers'. These companies are making the market that their customers trade in, rather than sending their orders on to the broader market. A hard examination of the world of currency, though, reveals that such a policy is actually necessary to making it possible for small retail trades to be placed, and although it is frequently abused, it is not necessarily a nefarious way of doing business.

The reason this is true is because there is no real 'Forex market', like there is for ordinary types of trading. To demonstrate this, company stocks are available only on traditional stock exchanges -- the New York Stock Exchange being one of the most prestigious. Every trade that are executed through exchanges like the American Stock Exchange is cleared under the auspices of the exchange, traded in accordance with the standards of the exchange and moved through brokers that are regulated by the exchange. Stock exchanges set the daily hours for business and have the authority to determine whether any stock or brokerage should be removed or suspended due to policies which run the risk of compromising the overall market. They exist at actual physical addresses and are themselves monitored by government offices.

The Forex market, by contrast, is made up mostly of major organizations that need to swap currency with other nations. They are major players; financial groups and large conglomerates which desire to convert capital from one currency to a different one so that they can trade goods from one country to a different one. Consider when a corporation in Australia markets some products in Canada. The payment will come as CAD, but the business will need to pay for its bills in Australian Dollars. It will need a convenient means to transfer its currencies virtually every business day. Companies like this and the banks they employ to exchange the currency are the real market, and small time traders are incapable of trading in this environment; we simply don't have the significant amounts of capital that would be of interest to the real currency players.

That's why retail Forex brokers trade with their own customers. These brokers can take in smaller trades of the variety we can do, and then they just bundle them together. Then they execute more substantial offsetting trades on the broader market making use of agreements they've made with 'Liquidity Providers'. With our tiny accounts we could never attract the attention of the big time banks. It just wouldn't be reasonable for them.

And so, retail brokers needs to give out price values to its clients, but there's not any central exchange that assures the prices at any given time. A broker must work with prices fed to it by its bank(s) which may not be in tune with the prices provided by other liquidity providers. Those variations are evident in the variation between broker quotes. From this fact arises the necessity for a brokerage to make the market for its clients, not purely from a penchant to screw them (although some few most likely do). Any ethical retail broker will not endeavor to gain from its clients by manipulating prices, but it has to nonetheless take the other side of its customers' trades so that they can honor them.

So, to sum it up, we see that retail brokerages have the need to take the opposite side of all except the most sizable of their clients' trades, however they should not use this to unethically work to their detriment. With these circumstances the Forex speculator - particularly if he is just starting to learn forex - has to look out for his or her own interests. It is important to always carefully watch the price quotes and trade executions of their agency, and to pick that broker sensibly. It would be uncalled-for, though, to conclude that a broker who takes the other side of a client's trades is doing so to screw them. It is an indispensable, if distressing part of the retail foreign exchange business model.

1 comment:

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