I wanted to know more about how brokers hedge our positions and why. Also, how do they make money. I have some kind of an idea but i hope that someone would correct me if i am wrong and tell me which concept is correct.
Now, from my understanding, brokers make money either through spreads or commissions. And I saw a lot of reviews about brokers taking the other side of our positions to minimize risks. But what I dont understand, why do they do this, even though they are already making money through the spreads or the commissions. In case of an ECN/STP/NDD broker, our trades should be sent to the liquidity providers to be executed in the market.
Also, from my understanding, hedging mean taking the opposite of a trade (offsetting the trade), so if I go long, the hedged trade would be short. In that manner, why and how would the broker benefit from that? If i won the trade, the broker will lose and pay me. And if i lost, he will profit from my trade as well as his hedged trade. It makes no sense if it is intended to minimize risk.
And the other concept which i dont think is right but i saw a lot of traders talk about, is that hedging that is made by the broker is the other way around. In which, if i go long, the broker will also go long and nice verse. Where if i won, he will win as well and pay me the money but he will make money from the spread or commission only. And if i lose, the broker will also lose, but i will pay him the money he lost, and he will make money again from the spreads and commissions only.
I see that the second concept is the best but i don’t understand how is that named “hedging” while hedging is offsetting the trade? And if the first concept is the right one, isn’t that make all brokers market makers? As from my understanding, all ECN/STP/NDD should follow the second concept and not trade or hedge against us?
Also, I emailed some brokers and some of them said that: their counterparties (LPs) are the ones who hedge my positions not them, so are they are not considered market makers? But again, how the LPs benefit or minimize the risk by opening trades opposite to our trades? What if my trade position is going to be profitable? Shouldn’t they follow the second concept?
Another thought that is in my mind that may clarifies that first hedging concept (opposite trades), is that when i go long on EURUSD, i am buying EUR and selling USD. so by hedging, maybe, they mean they find me someone who is shorting EURUSD, so i can buy from him the EUR and sell him the USD as well.
I really don’t know, i have a lot of thoughts and questions. And i am afraid i am mixing everything up. So i have someone could clarify them to me.
Thank you and sorry for the long post.