My firm belief is that while trying to maximise earnings the retail brokers are bending the rules of the game in way to suit themselves. This in return turns them against their very client – the forex trader they are now effectively playing against.
The purpose of this post and the ones to follow is to explore this conflict of interest where the retail forex broker who is supposed to provide a service to the client (forex trader) is benefiting directly from applying tactics like slippage, requote, amendment or cancellation of trades etc.
Why it is so hard for the retail forex trader to make money trading against retail brokers. Yes “against” not “with” you’ll soon find out what I mean. This is not saying that if you are trading with a bank or on an exchange it is easier to make money – only the players and some of the rules of the game are different, but it would still be quite hard to make money consistently – otherwise everyone would be doing it.
So let’s start with the basics the way I see them.
Forex is an OTC market. What does that mean to the Forex Trader?
Over-the-counter (OTC) or off-exchange trading is done directly between two parties, without any supervision of an exchange (Wikipedia)
No prise promise, no prise is the same
Different brokers can and do quote you different prices for the same pair. In fact internally the broker creates an aggregate of all the price feeds of its counterparties and this is what you see on your screen as a bid/ask spread. There is no obligation on the broker’s side on what the price should be and if it should match someone else’s price or to give you the best market price or anything like that.
So what is stopping the brokers from quoting you whatever they want? Arbitrage – if the price deviates too far from the average market price a smart arbitrageur can come and take advantage of the misaligned broker.
Retail Forex Broker’s tactics to maximise profits
Brokerage is a business and as every business people are in it to make money it is not different with forex brokers. In theory the retail broker should be profiting from a mark-up on the spread in case of a non-commission broker or commission for a commission based broker. The reality is that in order to be profitable some brokers are not hedging all positions and apply different tactics to maximise profits:
Slippage occurs when a trader places a Market Order and by the time the order is passed to a counterparty the price has changed. Or, when the best bid/ask size is less than the size of the order then the first part of the order is executed on the best bid/ask price, next chunk on the next best price and so on. Unfortunately some terminals like MetaTrader4 are not showing the bid/ask ladder and there is no detailed information on which bid/ask prices were hit by the market order. While for small market orders this is 50/50 – half of the time the price difference should be in the forex traders favour half of the time in his disadvantage. A dishonest broker can pocket the difference and when the price is better and fulfil the trade on the requested price and vice versa when the price is worse off pass it back to the forex trader in the form of slippage.
Requotes appear usually when the price cannot not be filled – this is more an effect of a volatile market but there are brokers who can issue requotes more often. Requote is similar to slippage but instead of the order being executed, when the price has changed the new price is returned to the trader to confirm execution. A dishonest broker can use requotes as a tool not let the trader enter a profitable trade by constantly requoting a new price.
Amending or cancelling trades
Unless in extreme cases caused by hardware or software failures the very definition of OTC someone is giving you a price and you are to decide if you want to trade on it or not. In some cases it is the seller that makes a good deal (getting a better price compared to the overall marker) in some cases it is the buyer – in our case it is almost always the retail broker that is pocketing the difference when in his favour and passing the loss to the client in the opposite scenario.
Generally when you hear “We are cancelling/amending your trade because the price quoted (the one that you traded on) is not a market price, is a spike, is a technical glitch etc…” – this is just saying that the order has had a price different from the average price of the other market makers and most probably the difference is in the forex traders favour. Otherwise why would the retail broker change a trade that he is actually making money on?
Are retail forex brokers actively playing against the forex trader?
No one apart from the broker himself really knows, what we can confirm is that there is a great incentive and a wide toolset for a broker to bend the scales in his favour in order to make more money. With 90% of the forex traders losing money on a regular basis there is no need to cheat the forex trader out of his money all of the time, all that needs to be done is to take the opposite side of the trade of a losing trader and give slightly worse off prices to the winning trader. All of this and much more will be covered in the next post – How Forex Brokers actually make money.