They're not Brokers --- they're Market Makers

Beginner Questions
1

The CFTC’s proposed new regulations for retail forex are officially titled: “Regulation of Off-Exchange Retail Foreign Exchange Transactions and Intermediaries”. What the regulations basically address is the relationship between retail forex customers
(you and me), and their brokers (Oanda, FXCM, IBFX, etc.).

FOREX POP-QUIZ:

Q: How many times does the word “broker” appear in the CFTC’s proposed new regulations?

A: Zero — except in reference to Introducing Brokers (who do not execute trades for customers).

There’s much more to this than just a random choice of words. The CFTC does not recognize the existence of a “retail forex broker”. The registered entity you call your “broker”, the CFTC calls a “dealer” — and they have made up a new designation
(or title) for these entities: [B]Retail Foreign Exchange Dealers (RFED’s).[/B]

Let’s distinguish between a “broker” and a “dealer”.

When you sell your house, you likely engage the services of a real estate agent or broker, to act on your behalf; and this person has a specific fiduciary responsibility to obtain the best deal and the best terms for you.

On the other hand, when you sell your gold coins, you likely visit your local coin dealer to hear his BID price; and if his price is acceptable to you, you will likely sell to him. He has a moral obligation to deal with you honestly, and that includes honestly giving you the current market price of gold. But, he has no fiduciary responsibility to help you obtain the highest price possible for your coins. He trades with you for his own benefit, not yours.

The CFTC says that the entities who solicit and transact your retail forex business are dealers, like the gold-coin dealer —
— not brokers, like the real estate broker.

[B]Furthermore, they say that all these forex dealers — RFED’s — are market makers.[/B]

All the stuff you’ve been told about “no dealing desk” and “straight-through processing” does not alter the fact that your so-called “broker” is the BUYER when you sell, and the SELLER when you buy. Furthermore, this places your “broker” in a conflict of interest with you, his customer.

“Conflict of interest” sounds unscrupulous, even illegal, but is isn’t. The conflict of interest which naturally exists between you and your forex dealer is no more evil than the conflict of interest which naturally exists between you and your coin dealer. But, this conflict of interest has to be emphasized, because of the no-dealing-desk smoke-screens that some forex dealers have thrown up in recent years.

Rest assured that the CFTC proposed regulation of retail forex WILL BECOME LAW, with the possible exception of the notorious proposed 10% margin requirement. When these proposed regulations become law, every forex dealer (RFED) will be required to furnish to every prospective retail forex customer a Risk Disclosure Statement which essentially says what we’ve just discussed. This Risk Disclosure Statement applies to all RFED’s, regardless of how they handle customer orders.

To spell it out:

[ul]
[li]All RFED’s (what we used to call brokers) are MARKET MAKERS
[/li]

[li]A built-in conflict of interest exists between all RFED’s and their customers
[/li]

[li]It doesn’t matter what your RFED (broker) does with his side of your trade (whether he holds it, offsets it in-house, passes it upstream to an ECN or directly to a bank), he is still dealing with you as a MARKET MAKER.
[/li]He is not your “agent”. He is not your “broker”. He is a “dealer”, dealing for his own benefit.
[/ul]

Here is the actual text of the Risk Disclosure Statement, which your RFED will be required to give to you, and you will be required to sign, as published in the Federal Register. This WILL become law:

Risk Disclosure Statement

OFF-EXCHANGE FOREIGN CURRENCY TRANSACTIONS INVOLVE THE LEVERAGED TRADING OF CONTRACTS DENOMINATED IN FOREIGN CURRENCY CONDUCTED WITH A FUTURES COMMISSION MERCHANT OR A RETAIL FOREIGN EXCHANGE DEALER AS YOUR COUNTERPARTY. BECAUSE OF THE LEVERAGE AND THE OTHER RISKS DISCLOSED HERE, YOU CAN RAPIDLY LOSE ALL OF THE FUNDS YOU DEPOSIT FOR SUCH TRADING AND YOU MAY LOSE MORE THAN YOU DEPOSIT. YOU SHOULD BE AWARE OF AND CAREFULLY CONSIDER THE FOLLOWING POINTS BEFORE DETERMINING WHETHER SUCH TRADING IS APPROPRIATE FOR YOU.

(1) TRADING IS NOT ON A REGULATED MARKET OR EXCHANGE—YOUR DEALER IS YOUR TRADING PARTNER WHICH IS A DIRECT CONFLICT OF INTEREST. BEFORE YOU ENGAGE IN ANY RETAIL FOREIGN EXCHANGE TRADING, YOU SHOULD CONFIRM THE REGISTRATION STATUS OF YOUR COUNTERPARTY. The off-exchange foreign currency trading you are entering into is not conducted on an interbank market, nor is it conducted on a futures exchange subject to regulation as a designated contract market by the Commodity Futures Trading Commission. The foreign currency trades you transact are trades with the futures commission merchant or retail foreign exchange dealer as your counterparty. WHEN YOU SELL, THE DEALER IS THE BUYER. WHEN YOU BUY, THE DEALER IS THE SELLER. As a result, when you lose money trading, your dealer is making money on such trades, in addition to any fees, commissions, or spreads the dealer may charge.

(2) AN ELECTRONIC TRADING PLATFORM FOR RETAIL FOREIGN CURRENCY TRANSACTIONS IS NOT AN EXCHANGE. IT IS AN ELECTRONIC CONNECTION FOR ACCESSING YOUR DEALER. THE TERMS OF AVAILABILITY OF SUCH A PLATFORM ARE GOVERNED ONLY BY YOUR CONTRACT WITH YOUR DEALER. Any trading platform that you may use to enter off-exchange foreign currency transactions is only connected to your futures commission merchant or retail foreign exchange dealer. You are accessing that trading platform only to transact with your dealer. You are not trading with any other entities or customers of the dealer by accessing such platform. The availability and operation of any such platform, including the consequences of the unavailability of the trading platform for any reason, is governed only by the terms of your account agreement with the dealer.

(3) YOUR DEPOSITS WITH THE DEALER HAVE NO REGULATORY PROTECTIONS. All of your rights associated with your retail forex trading, including the manner and denomination of any payments made to you, are governed by the contract terms established in your account agreement with the futures commission merchant or retail foreign exchange dealer. Funds deposited by you with a futures commission merchant or retail foreign exchange dealer for trading off-exchange foreign currency transactions are not subject to the customer funds protections provided to customers trading on a contract market that is designated by the Commodity Futures Trading Commission. Your dealer may commingle your funds with its own operating funds or use them for other purposes. In the event your dealer becomes bankrupt, any funds the dealer is holding for you in addition to any amounts owed to you resulting from trading, whether or not any assets are maintained in separate deposit accounts by the dealer, may be treated as an unsecured creditor’s claim.

(4) YOU ARE LIMITED TO YOUR DEALER TO OFFSET OR LIQUIDATE ANY TRADING POSITIONS SINCE THE TRANSACTIONS ARE NOT MADE ON AN EXCHANGE OR MARKET, AND YOUR DEALER MAY SET ITS OWN PRICES. Your ability to close your transactions or offset positions is limited to what your dealer will offer to you, as there is no other market for these transactions. Your dealer may offer any prices it wishes, and it may offer prices derived from outside sources or not in its discretion. Your dealer may establish its prices by offering spreads from third party prices, but it is under no obligation to do so or to continue to do so. Your dealer may offer different prices to different customers at any point in time on its own terms. The terms of your account agreement alone govern the obligations your dealer has to you to offer prices and offer offset or liquidating transactions in your account and make any payments to you. The prices offered by your dealer may or may not reflect prices available elsewhere at any exchange, interbank, or other market for foreign currency.

(5) PAID SOLICITORS MAY HAVE UNDISCLOSED CONFLICTS. The futures commission merchant or retail foreign exchange dealer may compensate introducing brokers for introducing your account in ways which are not disclosed to you. Such paid solicitors are not required to have, and may not have, any special expertise in trading, and may have conflicts of interest based on the method by which they are compensated. Solicitors working on behalf of futures commission merchants and retail foreign exchange dealers are required to register. You should confirm that they are, in fact registered. You should thoroughly investigate the manner in which all such solicitors are compensated and be very cautious in granting any person or entity authority to trade on your behalf. You should always consider obtaining dated written confirmation of any information you are relying on from your dealer or a solicitor in making any trading or account decisions. FINALLY, YOU SHOULD THOROUGHLY INVESTIGATE ANY STATEMENTS BY ANY DEALERS OR SALES REPRESENTATIVES WHICH MINIMIZE THE IMPORTANCE OF, OR CONTRADICT, ANY OF THE TERMS OF THIS RISK DISCLOSURE. SUCH STATEMENTS MAY INDICATE POTENTIAL SALES FRAUD. THIS BRIEF STATEMENT CANNOT, OF COURSE, DISCLOSE ALL THE RISKS AND OTHER ASPECTS OF TRADING OFF-EXCHANGE FOREIGN CURRENCY TRANSACTIONS WITH A FUTURES COMMISSION MERCHANT OR RETAIL FOREIGN EXCHANGE DEALER.

I hereby acknowledge that I have received and understood this risk disclosure statement.
___________________ Date
___________________ Signature of Customer

I have re-formatted the Risk Disclosure Statement, as printed in the Federal Register, to make it more readable. None of the wording has been changed.

Here is a link to the entire CFTC proposal, as published in the Federal Register. The Risk Disclosure Statement is covered in
§ 5.5 on pages 3312-3313:

It gets better!

Paragraph (e) of § 5.5 says that your RFED must include, along with the Risk Disclosure Statement, the following information, for each of the past four calendar quarters:

[ul]
[li]The total number of non discretionary retail forex accounts maintained by the retail foreign exchange dealer or futures commission merchant.
[/li]

[li]The percentage of such accounts that were profitable.
[/li]

[li]The percentage of such accounts that were not profitable.
[/li][/ul]

And, if you request it, your RFED must furnish to you the same information listed above for each calendar quarter for the past five years.

For people who trade through a U.S. forex “dealer”, things are about to get MUCH more transparent.

3

Nice!

As always, thanks for going not the extra mile, but the extra two miles to share this knowledge!

I’m looking forward to some inside info from my dealer in the future then.

I guess we may finally learn if the 95%-5% relationship is true or not.

4

If that is completely accurate, and if I’m reading it correctly, doesn’t that suggest that the concept of an ECN or STP is a complete lie? In other words, shops that claim to offer ECN access really are operating more like a DD?

5

such a great explanation!

I also wonder what is REGULATED MARKET OR EXCHANGE? is it the market where a dealers buy currency for one price and resale it for other? do I understanding it correctly?

if dealers do resale currencys Is there any law regulation about price increasement which would simply regulates “Conflict of interest”, between the dealer and his customer(s)?
can we compair “Conflict of interest” with the spikes that we can see on the charts? RIGHT?
Is there a way a trader can trade directly on the REGULATED MARKET OR EXCHANGE if such exists except the way when a trader would become a dealer?
or am I asking very silly questions? I am new and dark in this area :confused:
what is " no-dealing-desk smoke-screens " some slang or something :slight_smile:
can you or anyone please answer my questions

thanks

6

Thanks for your comments, MacGyver.

Like you, I’m very curious to see those profitability percentages.

Hey, java guy

“Lie” is probably too strong a word. But, our brokers — I mean DEALERS — are going to have some explaining to do.

ECN’s exist. MB Trading routes all retail forex trades through an ECN (3DFX). And straight-through processing exists, at some dealers, as an order-processing protocol.

The CFTC has not said one word regarding either ECN processing, or straight-through processing. They have simply made the blanket statement that, for every RFED, the dealer is counterparty to every retail forex trade. Period.

This clearly challenges ECN dealers and STP dealers to prove that they ARE NOT counterparties to their customers’ trades, and therefore they ARE NOT market makers.

If those dealers take up that challenge, the argument should be fun to watch.

Hey, RenaLa

There is no “regulated market or exchange” for retail forex. Regarding your question “what is a regulated market or exchange”, examples would be the New York Stock Exchange (for equities), and the Chicago Mercantile Exchange (for commodity futures).
No comparable exchange exists for trading spot forex.

Regarding your second question, the conflict of interest which the CFTC alleges between dealers and their customers could, in theory, encourage stop-running on a small scale. That is, an unscrupulous dealer might momentarily widen his spread by a few pips, in order to pick off customers’ stops, if the dealer were holding the other side of those customer positions. If this were to occur, it would cause an almost imperceptible blip in price, not a price “spike”, as you suggested.

As I said in my post, there is nothing inherently evil about a conflict of interest. A conflict of interest naturally exists between any buyer and seller: the buyer wants the lowest price he can get, and the seller wants the highest price he can get. You would like to have lower spreads from your forex dealer, and your dealer would like to charge higher spreads. Generally in commercial transactions, conflicts of interest lead to price discovery, which is one of the functions of an efficient market.

7

Interesting read Clint, Thanks!

Does the “dealer” name apply to other variations of online trading, commodities, equities, and futures?
It’s disconcerting to think of your broker as the other side of your trade, but in the long run, it’s most likely they aren’t trying to trade against anyone for profit, but to provide liquidity for their traders.

I wish government in ANY form would stop trying to protect us from ourselves, but instead, focus on bogus trading companies and brokerage houses. I don’t see the CFTC or any other governmental agency running to Vegas, or Atlantic City, and limiting bet sizes, or odds, to protect people from losing their money gaming.

The more laws we have, the closer to anarchy we get;)

Cheers!

8

[B]Hey, Jay[/B]

The CFTC has nothing to do with equities, so we have to remove that from your question.

Commodities and futures are the same thing (unless, by commodities, you mean the [I]cash[/I] market for copper, or pork bellies, or whatever). The CFTC definitely regulates commodity [I]futures[/I].

The Proposed Regulations we’ve been talking about here pertain only to the retail forex market. What we call our commodity brokers, the CFTC calls Futures Commission Merchants (FCM’s). These Proposed Regulations apply to FCM’s ONLY IF they deal in retail forex as well as commodity futures. If they do, they will be required to register as RFED’s (for the forex side of their business). They will continue to be FCM’s as far as their futures business is concerned.

I don’t know whether or not the CFTC distinguishes between (1) commodity brokers who operate only on regulated commodity exchanges, as opposed to (2) commodity brokers who also operate in the off-exchange futures market.

As for forex dealers, such as FXCM, which are forex only, after the Proposed Regulations become law, such dealers will register and be designated as RFED’s. Apparently they will no longer be FCM’s.

In the past, it was just accepted that all forex brokers were market makers (taking the other side of our trades). In recent years, some dealers have convinced the trading public that NDD is different, and superior. Now, the CFTC is saying, in effect, that there is no such thing as an NDD dealer. They’re all market makers, and always have been.

Over the past 12 years, or so, — during the “wild west” era of retail forex — there have been some really bad cases of fraud and abuse in this business, mainly because the CFTC didn’t have the legal authority to regulate retail forex and prosecute the bad guys. That’s about to change, dramatically.

There are provisions in these Proposed Regulations to restrict some of the nastier things (like front-running customer orders) which some of the sleazier forex dealers have gotten away with in the past.

Actually, cracking down on fraud and abuse by certain sleazy elements in the industry is what these Proposed Regulations are all about.

We (retail forex customers) have been preoccupied with the leverage issue, because that one issue has the capacity to cripple or destroy spot forex trading in the U.S.

But, if the CFTC were to throw that out, leaving leverage just as it is, then these Proposed Regulations would be a good thing for all retail forex customers.

9

Thanks Clint.

I’m greatful for the transparency coming our way. I always knew “brokers” were criminals but to hear that some have been outright deceiving us by implying that no dealing desk somehow meant that our orders weren’t being manipulated.

Those dealers make so much money as it is. Anyway I will also be looking to see some % of winning and losing accounts. Will they just give percents or will they also disclose amounts won and lost?

10

Hey, Johnny

More transparency will be a good thing, for sure.

As for criminals, there certainly have been some over the years; and there may be a few left, even now. But, I wouldn’t paint the whole group with that brush.

Many traders, myself included, have a broker — I mean DEALER — that we like and trust. There are some good ones out there.

A lot of the bad apples got run out of business when the CFTC raised Net Capital Requirements so drastically last year —
from half a million USD to 20 million USD.

These current Regulations (when they become law) should clean up the business even more.

As for the forthcoming requirement to report winners and losers, I would bet money that forex dealers will do what’s required by law, and no more. In other words, they’ll report percentages, not dollar amounts.

11

You know what I’d like the CFTC to change. And I dont know if this is with all brokers or just mine. (IBFX…I think oanda is open on the weekend)

That the market and your broker closes on friday, and closes off access to trading account and ability to adjust any trades you left on, until sunday evening, which of course if after a gap.

Sure sometimes it works in your favor.

But, it just doesn’t make any sense. They will honor a SL, so it’s obvious i’ts on their servers somewhere. So, if the servers are on, let us have access to our live trades.

It just doesn’t seem fair. The market is moving so let us at our trades.

12

That’s what I was afraid of, and while I’m very intrigued to see those numbers, they will only be moderately useful. If most of the winners with a given “dealer” are the larger accounts, that will make the percentage less meaningful.

13

I think the actual number of winning traders will be closer to 85% as opposed to the harsh figure of 95%. I was also considering opening a live account for me to begin live trading after sufficient demo practice with FXCM. However, one of their support representatives and their websites have gone [B]at length[/B] to distinguish themselves as a [B]non-dealing desk broker.[/B] If the information presented above is true, how will brokers such as FXCM be able to reconcile their previous statements that they have been making? Would they count as [B]untrue?[/B]

14

Phoenix,

I agree with you — sort of.

I almost never hold trades open over the weekend, so usually I’m happy to walk away from trading for 48 hours, and have a life.

But, on those rare occasions when I do have a trade open past 5pm ET on a Friday, I fret about it all weekend. It’s those times that I agree with you 100%.

java guy,

Good point. I hadn’t thought of that.

When dealers start rolling these numbers out, maybe we’ll be able to persuade them to report according to account size.

Trizzle,

I hope you’re right about the percentage. That frequently-quoted 95% failure rate seems so grim.

Regarding all the advertising over the past couple of years about no-dealing-desk, ECN-order-execution, and straight-through processing, I think a whole new vocabulary is in order.

Dealers are going to have spell out in detail how they process orders, and how their order-handling protocols benefit their customers.

If a dealer truly has an effective firewall which prevents their own proprietary trading desk from seeing customer accounts, positions and pending orders, then that dealer needs to convince the public that the firewall is real and that it’s effective.

Complete transparency could be the dealers’ best marketing strategy in the future. I hope they see it that way.

16

More transparency.

In the CFTC Proposed Regulations for Retail Forex, [B]§ 5.18 Trading and operational standards[/B] contains some intriguing provisions. § 5.18 begins on page 3323 of the Federal Register.

Reading the whole section will make your eyes glaze over. But, [B]paragraph (b) sub-paragraphs (4)(iii) and (4)(iv)[/B] are worth a look. Here they are. I have added the wording in brackets [ ], and I have bolded certain key phrases for emphasis.
Otherwise, the wording is as printed in the Federal Register:

§ 5.18 Trading and operational standards.

Prior to engaging in a retail forex transaction, each retail forex counterparty [this means your forex dealer] shall, at a minimum, establish and enforce internal rules, procedures and controls to record and maintain essential information regarding customer orders and account activity, and to [B]provide such information to customers upon request.[/B] Such information shall include:

[ul]
[li]If a trading platform is used, daily logs showing each price change on the platform, the time of the change to the nearest second, [B]and the trading volume at that time and price;[/B] and
[/li]

[li][B]Any method or algorithm used to determine the bid or asked price for any retail forex transaction[/B] or the prices at which customer orders are executed, including, but not limited to, any markups, fees, commissions or other items which affect the profitability or risk of loss of a retail forex customer’s transaction.
[/li][/ul]
For those of us who don’t have volume information included in our charting packages, volume will be a nice addition.

But, the biggie is the one about algorithms. Your dealer will have to tell you exactly how he determines the BID and ASK prices offered to you. Here’s why I think this is important:

Once your broker spells out the formula for determining his BID and ASK prices, he won’t be able to manipulate spreads for the purpose of stop-hunting, without deviating from his published formula and risking the wrath of the CFTC.

It will be interesting to see what dealers do about the common practice of widening spreads during news releases and during periods of high market volatility. How will they explain those actions, in terms of their algorithms?

17

Oh man. I’d love to see that stuff.

18

Dealing desk and ECN may be the same in terms of pairing your trade, honestly who thinks an ECN will accept micro accounts and .01 lots to send to the larger banks, but important difference is operating cost. ECNs tend to give you much better spreads at a commission costs. From what I’ve seen, ECNs usually have a fairly response server and so do reputable Dealing Desk. But personally, I’d rather have a 4 pip spread on the CJ, pay a small commission (.49 for mini lot with MB) versus an 8 pip spread on dealing desk. With ECN I don’t need the price to move as far to make a profit and I’m paying less for the trade overall.

But the proposed rules are great in terms of bringing transparency to the market. It is amazing to lookup brokers and see how many have some substantial fines against them for being dishonest to the consumer about the services/products/rules of their dealing desk.

21

They are. That’s exactly what the CFTC is saying. When you buy or sell, you are trading with your dealer, and nobody else.

What your dealer [I]subsequently[/I] does with his side of your trade has nothing to do with the dealer/customer relationship that exists between your dealer and you.

I agree. About 4 years ago, I took a hard look at MB Trading, comparing them with my broker (FXCM).

At that time, MB’s spread + commission was 25% less expensive (on average) than FXCM’s spread.

I don’t know about now, but I wouldn’t be surprised if MB Trading is still much less expensive than any non-ECN dealer.

Absolutely right.

This is the sort of abuse the CFTC is trying to get at; and this is precisely what they should be going after.

And — with one glaring exception — that’s what their current Proposed Regulations will accomplish. The glaring exception is their misguided intent to reduce allowable forex leverage.

If they do that, none of their other regulations will matter, because nobody will hang around to trade forex in the U.S. — not when it’s so easy to move your trading to the U.K. and keep leverage of 100:1, or more.