Is your broker trading against you? To answer your doubts, here are some crucial signs to find out the truth and what type of broker you should choose.
The forex market is the biggest global market with millions of participants from all across the globe. Transactions in the forex market must occur over-the-counter (OTC) between agreeable buyers and sellers. That being said, forex brokers play a pivotal role in the market because they are able to give traders access to the market.
As a trader, it's highly crucial to pick an honest broker for trading. It might be challenging, especially if you're a newbie because there are many unregulated brokers in the market. So, you need to gain as much knowledge as possible about this.
There are various qualities that you would want to find in a broker. Some of the essential things are the safety and reliability of the broker itself. You must know that in forex trading, a broker can choose to trade against their clients. In fact, most brokers actually tend to trade by holding the opposite position to their clients. However, the exact mechanism may vary from one broker to another. What matters most is identifying the kind of trade system you're going to work with before choosing the broker.
Types of Brokers
- Dealing Desk (DD) Broker
This is the type of broker that is usually regarded as the broker that most likely trades against their clients. Dealing Desk broker (also known as Market Makers) is the type of broker that sets both the bid and asks prices on their systems and makes transactions at these prices with their clients. By doing so, the broker basically acts as the liquidity provider of the market.
This type of broker is also sometimes referred to as B Book brokers. To generate income, Dealing Desk brokers would charge spread to their customers. Spread refers to the difference between the ask and bid price and is often fixed by the market maker. Usually, the spread amount is quite reasonable as a result of tough competition with other market makers.
Moreover, as counterparties to each forex transaction in terms of pricing, Dealing Desks must take the opposite side of the trade. So whenever you sell, they must buy from you, and vice versa. In other words, they are trading against you and your losses are often equal to their profits. As a result, the market maker model generates a conflict of interest between brokers and their clients. There's a common perception that traders feel unsafe when trading with Dealing Desk brokers because they're concerned that they're going to be subjected to some tactics that could only profit the broker and make them lose the trade.
- No Dealing Desk (NDD) Broker
Meanwhile, No Dealing Desk (NDD) brokers use liquidity providers to link the orders from their clients. So in other words, they only act as the middle man that sends their clients' orders directly to the liquidity providers or Multilateral Trading Facilities (MTFs). This type of broker is often referred to as A Book broker. They might technically be trading against their clients by taking the opposite side of the trade, but they're doing it in a risk-neutral approach to the market and are looking to immediately offset the trade. So they're not directly trading against their client in spirit, but only in technicality.
There are two types of NDD brokers: Electronic Communications Network (ECN) and Straight Through Processing (STP). ECN brokers allow their clients to interact directly with participants in the vast network of different prices from many other traders. As a result, ECN brokers can offer better access to optimal quoted prices but often demand large sums of deposit and charge a commission for each order. On the other hand, STP brokers transfer the orders from traders to their liquidity providers. They usually have a fully automated dealing system for the clients, leaving no room for human-related errors, costs, and delays.
Typically, NDD brokers work together with several liquidity providers to provide the best price for the clients. Instead of charging from fixed spreads, these brokers make money by charging commissions on the volume of trades. That means they will earn the same amount of money regardless of the trade's outcome so there's no conflict of interest. Also, the asking price and bids tend to be variable because there are several quoted prices from numerous market sources. This means that the spread is variable and it can be quite high or small, depending on the time frame.
With no conflicting interests at hand, NDD brokers are often considered safer, hence the higher popularity among traders. These brokers are more likely to have a genuine intention of supporting their clients to win because winning means increasing trading volumes and thus sustaining the brokers' profits.
These brokers are less likely to quote the price again once the client has given the order. This is because NDD brokers are not holding any positions for themselves, so they usually execute the trade at the standard asking price.
Another advantage is that the system that NDD brokers use is digitized, so there is a low probability of delays. The electronic system also allows a broader approach to different sources of liquidity quotes and reduces the possibility of delays.
4 Things to Consider
The easiest way to figure a broker that would trade against you is by asking them directly about their dealing system. However, this method rarely effective because typically, they would only give a vague answer. Perhaps they're uncomfortable for admitting their status as counterparties to your trades or don't educate their staff enough about how they operate and make money, so the team can't explain to you in good details. This is why you should be able to spot it on your own by paying attention to the following things:
Leverage is a great way to help small traders make big trades, but what many forget is that leverage is extremely risky. By taking the leverage, they basically open a huge position that would cost them a lot if they lose the trade. In this case, forex brokers, especially market makers are typically aware that most newbies are inexperienced and there's a high chance that they're going to misuse the leverage. Thus, they usually offer high leverages to attract new clients.
In other words, many market makers are using high leverage as a part of their marketing offers. They'd invite you to take a lot of risks, knowing that it's not really a good move to do especially if you're just starting. Generally, NDD brokers that are connected to liquidity providers cannot offer leverages more than 100:1. Meanwhile, market makers can offer any amount of leverages they want so keep an eye on that.
Re-quoting is another trick that market makers might use to trade against you. Sometimes, when the market is going up strongly and you choose to buy, the transaction may be delayed for a few seconds and instead of processing the position you selected, the screen will give you a new price that is less favorable than the price you wanted to enter. Similarly, when the price is going down significantly and you chose to go short, it might not let you enter immediately. This is called re-quoting and it's certainly not profitable for traders. Simply put, the broker is not allowing you to go with your ideal position because your loss is their profit.
Another thing to consider when choosing a broker is the possibility of slippage. In this case, the broker may slip the price when you want to open or close a position. When you click the buy button, suddenly the price goes higher, so you end up entering the trade with a higher price. Getting big slippages is definitely not great because it makes you get smaller profits with winning positions and lose more with losing positions.
NDD brokers like ECN and STP should directly transfer the orders given by traders to the liquidity providers. Similarly, these brokers should also directly pass on the quoted price from liquidity providers to the clients. For every transaction, these brokers are allowed to charge a fixed commission as a way to generate income. However, some brokers may use a trick to increase their profit by adding markups to the price.
Markup is an additional pip added by the broker to the liquidity provider's base spread. So, the price offered would be higher than the actual quoted price from the liquidity provider. In this case, it's best to avoid brokers that add markups to their clients' transactions. However, since the practice is quite common these days, brokers with reasonable marked-up prices are still worth considering.
The Bottom Line
The type of broker that you pick can significantly impact your trading performance. This article shows that it's quite common for DD brokers to trade against their clients and earn profit from it. There are several methods that they can use which generally favor them and not the clients. If you're new to forex trading, you should be aware of different ways used by brokers to trade against you.
However, it's also worth mentioning that market makers can offer an excellent opportunity with their high leverage and various trading instruments. Trading in such conditions can be profitable if you're an experienced trader with great control over your actions. That is why trading with a DD broker is not always a bad choice, because it depends on your trading skills, goals, and needs. However, whatever your choice is, make sure to seek a genuine broker that you can trust and would help you achieve your goals.