Hello everyone -
When a retail forex trader longs or shorts a currency pair on an online platform like Forex.com, who exactly is his counterparty? Is his broker also acting as a “dealer”? If so, how is the broker always willing to engage in a transaction? Do they have some hedging or offsetting strategy?
Thank you for your help.
Your broker is always your conterparty. Much like a bookie at the local racetrack.
How they manage risk is their business. They are not a financial advisory firm. But just like 0’s on a roulette table, spend puts the olds back in favour of the house
On your individual trade (which is actually a bet, you’re not trading in the underlying market or participating, at all) it’s your broker who is the counter party - so it’s your broker who offers a rate at which you accept (the spot rate). The only exception to this rule is with a Direct Market Access account (DMA) - which are very expensive, and for good reason too.
Your retail broker will though aggregate all the buy and sell bets to calculate a net risk. They ‘may’ offset this risk into the underlying market through there liquidity providers.
Which institutions function as liquidity providers for brokers?
Some do; some don’t.
They vary all the way from “no laying-off strategy at all” to “automatic laying-off of their own net liabilities in the underlying market”.
There isn’t a reliable way of knowing what any individual broker does, on that front, as they’re generally not obliged to disclose it to anyone.
It’s important, though, not to be fooled by expressions like “ECN” and “no dealing desk”: countless regulatory rulings arising over marketing claims and trades descriptions, in recent years, have shown these claims to be completely meaningless.
As a general rule, the bigger, longer-established “brokers” who are well regulated in a jurisdiction that’s also itself well regulated by law are more likely to be offsetting their own liabilities and less likely, overall, effectively, to be primarily incentivised by the motivation for the customers to lose money. The unregulated ones, and the ones who have chosen to be regulated in places like Cyprus, the Caribbean and the Seychelles are much, much higher-risk, overall. But there’s no absolute certainty in any individual case.
Unless you use a genuine direct market access broker (such as “Interactive Brokers”), who simply places a trade on your behalf into the interbank market. But you need to be well funded, to do that. Too well funded for most of this forum’s members.
Unless you use a genuine direct market access broker (such as “Interactive Brokers”), who simply places a trade on your behalf into the interbank market. But you need to be well funded, to do that. Too well funded for most of this forum’s members.
I won’t be worry about that for a while.
It varies from broker to broker, and the relationships that they have.
Barclays Bank PLC, Citibank N.A., Deutsche Bank AG & Jefferies Financial Services are perhaps the top four most common. A quick search showed me this.
Not to mention Goldman and JP - i’m sure BoA also float around too.
How exactly does their relationship work? I mean: What does it look like when a given broker “lays off” its liabilities with a Barclays or Goldman?
From what I know, and this is by no means the complete picture, the relationship between the relative broker and the Liquidity Provider (LP) predominantly effects the following three key factors.
How does the broker profit on an exchange The school says, “Most retail brokers are compensated for their services through something called the “bid/ask spread.” Elaborate?
The spread they charge retail clients is wider than the interbank spread with LPs. The net difference is their profit when offsetting any liability.
Broker acts as an medium between the traders in a currency pair. However, it is not that broker is not act as an counter party. Because it is quite difficult to find a counter party trader who will have the equal quantity opposite demand at the same time. So broker in that situation acts as an counter party and settle the transaction with other trader as per own suitable time.
Thats not right at all bro, thats what they want you to believe. Read their PDS. Your risk lies with them and them alone. Well at least with the brokers most of us will trade with.
@philip338, it really depends on the broker’s business model.
For example, whether they’re an A-book, B-book, or hybrid type of broker.
If you want to know how Forex.com operates specifically, I’m sure @FOREX.com won’t mind providing an answer.
I’m sure they wont mind proving an answer - however lets not forget that the representative of Forex.com is employed to specifically promote Forex.com with the business’s best interests at mind. Asking the question, which is about the underlying business model, is never going to be explained with 100% clarity, honesty, trust, integrity or open willingness to disclose all the details - and anyone who believes this is not the case needs to stay in this industry for a little while longer. (No disrespect to Forex.com - this is true for all retail MM brokers)
Without trying to beat a dead cat once again, you only have to look at FXCM when they explained there business model here on BP. Jason was a great rep, and friendly. However he was employed to work for FXCM. FXCM was one of the largest US brokers (if not the largest at the time?), before being shut down for misleading clients with false claims about their business model and the relationship it has concerning its clients interest. Since then and prior to this taking place numerous other brokers were also fined for similar activities.
Unless your Not using Leverage
then The Broker Has to cover there ASS some how. If you Could afford to buy the 1Lot £100.000
out right
then the broker would not have any reason to be concerned about your trade.
But then you would Probably be looking at…>>>
Or
Amongst others…
Stop trashing the thread with screenshots - this is topic which deserves quality input.
This isn’t so at all. It’s totally wrong.
Wherever you’re getting your information from, Nathaniel, try somewhere different!![quote=“RISKonFX, post:18, topic:131392, full:true”]
Stop trashing the thread with screenshots - this is topic which deserves quality input.
[/quote]
It “deserves” it, but that’s asking a lot.
Hello @philip338,
When a retail forex trader places an order to buy or sell a currency pair, his broker is the counterparty to his trade. This is true regardless of whether the broker is FOREX.com or any other retail forex broker. To confirm this, simply review customer agreement of any well-regulated broker.
For example, in the US, retail forex is regulated by the CFTC/NFA and all regulated brokers are required to include the following risk disclosure statement which can be found on page 12 of latest version of our customer agreement which was last updated on 1 January 2018:
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.
What is a “Counterparty”?
Investopedia defines it like this:
A counterparty is the other party that participates in a financial transaction, and every transaction must have a counterparty in order for the transaction to go through. More specifically, every buyer of an asset must be paired up with a seller who is willing to sell and vice versa.
All trades require some sort of counterparty, so for example, the counterparty to an option buyer would be an option writer. One of the risks involved in any transaction is counterparty risk, which is the risk that the counterparty will be unable to fulfill his duties.
The last point above highlights why a retail forex trader always has a retail forex broker as his counterparty. While retail forex brokers are willing to assume the counterparty risk of retail forex traders (the risk that these retail traders are unable to cover their losses), the largest banks in the world (those which trade forex with each other in the interbank market) are not willing to assume the counterparty risk of individual retail forex traders or even the counterparty risk of smaller retail forex brokers.
However, big banks are willing to assume the counterparty risk of retail forex brokers like FOREX.com. These retail forex brokers will in turn act as counterparty to the trades of smaller retail forex brokers and individual retail forex traders.
Therefore, the fact that your retail forex broker is the counterparty to your retail forex trades is neither good nor bad. What matters is the quality of your broker.
It seems you are asking how your retail forex broker executes your orders. We established above that your broker is the counterparty for your retail forex trades regardless of the particular broker you choose. This means that, one way or another, your broker has to manage the risk on the other side of your trade. In fact, all retail forex brokers regulated in the US are referred to as Retail Foreign Exchange Dealers by the CFTC/NFA.
For our part, FOREX.com has always been open about our role as the market maker (AKA dealing desk) for the trades placed by our retail clients. We feel no reason to hide this fact, because at retail trade sizes, we believe market making is the best way to provide customers with reliable pricing while effectively managing our own risk. We are fully accountable for every execution and don’t outsource that responsibility to a third party.
Not always. Retail forex brokers rely on the big banks for liquidity, either directly as FOREX.com does, or indirectly as some smaller brokers do by clearing their own orders through larger firms like ours. Since all retail forex brokers, big and small, are dependent on the big banks for their liquidity, retail forex is generally open for trading 24 hours a day, 5 days a week, from 5pm Sunday to 5pm Friday New York Time.
When it’s 5pm in New York, it’s already the morning of the next day in Asia. Therefore, aside from the weekend (5pm Friday to 5pm Sunday), there are dealers manning forex desks of the big banks day and night to quote prices and provide liquidity to firms like FOREX.com. We in turn can provide liquidity to retail forex traders like you, while our institutional arm GTX provides liquidity to smaller retail forex brokers so their clients can also place trades.
Retail forex brokers can manage the risk on the other side of your trades in one of three ways, and each method has its pros and cons.
Option 1: Your broker can offset your buy orders with the sell orders of their other clients, and offset your sell orders with other buy orders). This is known as natural hedging and relies on a broker’s internal liquidity of buy and sell orders from clients.
Pro: This is a win-win scenario for trader and broker, because your order can be filled without having to depend on an external liquidity provider, and your broker gets to earn the full spread and be fully hedged (buyers offsetting sellers). Generally speaking, the larger a broker is, the more buy and sell orders its clients will place and the more internal liquidity in normal market conditions.
Con: For some smaller brokers, their internal liquidity might not be sufficient for natural hedging to occur as often. Even for larger brokers like FOREX.com, there are times the imbalance between buyers and sellers can be so great that natural hedging with internal liquidity is not possible. In either case, when internally liquidity is not sufficient for natural hedging, a broker must turn to option 2 or 3.
Option 2: Your broker can offset the risk with their external liquidity providers. For example, FOREX.com does this by looking at our net exposure to see if there are more buyers than sellers or vice versa. If there are more buy (sell) orders within our retail client base, then we can offset our net long (short) exposure placing a large buy (sell) order with a bank. Similarly, smaller retail brokers can offset their own exposure with a larger firm like our institutional arm GTX.
Pro: Your order is filled. Your broker is able to hedge its risk on the other side with a bank or a larger broker. Your broker’s external liquidity provider benefits from the order flow which they can use for their own internal liquidity to offset other institutional orders. This highlights how retail traders are connected to and contribute liquidity to the larger market even if it is indirectly through their retail broker.
Con: There is an another layer of dependency between your broker and their liquidity provider added to the process of offsetting the risk from your trade. Depending on how and how effectively your broker manages this risk, any price moves that occur in the interim can affect you (slippage), them (broker losses), or both. An extreme example of this was when the Swiss National Bank decided to scrap its currency ceiling 3 years ago.
- Another con with Option 2 which may not seem as important to you as a trader at first glance is that your broker stands to make less money than with Option 1, since they have to pay their liquidity provider’s spread to offset the exposure. You want to know that your broker has a sustainable business model. Consider how some brokers have tried to use Option 2 for all orders and ended up having to raise their account minimums as a result. Others found they could not stay in business at all and were acquired by brokers that have the flexibility and internal liquidity to use Option 1.
Option 3: Your broker might decide not to offset the risk either internally (Option 1) or externally (Option 2).
Pro: Your order can be filled without having to depend on an external liquidity provider as with Option 1. Your broker avoids paying their liquidity provider’s spread.
Con: Since your broker acts as the buyer when you sell and the seller when you buy, their interests may be in conflict with yours meaning a profit for you might mean a loss for them, or vice versa.
- This is the biggest concern traders tend to have with Option 3. While we won’t speak for other brokers, in 2016 which is the latest full-year data we have compiled, approximately 98% of FOREX.com’s average daily retail segment trading volume was either naturally hedged (Option 1) or hedged by us with one of our liquidity providers (Option 2). Therefore, Option 3 represented about 2% of FOREX.com’s average daily retail segment trading volume for the year.
