Market markets and ECN brokers aren't always what they seem, so are forex bonus schemes and scammers' objectives. What are the hidden truths and why you need to understand them?
Investors and traders will be set for good if they can choose the right broker. But, choosing the right broker is a bit of a complex issue. Most investors and traders are usually clued about online trading from brokers' advertising campaigns that may put aside the importance of accuracy, security, precision, and direct support. As brokers are responsible for all transactions and support traders to earn profits, you have to ensure that you're trading with the right broker and that the broker does fair business with you.
Many brokers promote services by offering discounts or free-of-charge "bundles". Although this solution seems to be interesting, one should take into account that the forex market evolves rapidly (electronic trading, new trading platforms, increased transparency, new capital regulations, competitive pricing, etc.). With the advancing of the forex market, so does the competition in the brokerage industry.
You can find differences in fees (spreads or commissions) and execution qualities among forex brokers. The majority of poor-quality brokers always trade against their clients and try to manipulate both the price and the execution of orders. The loss of their clients creates a profit for the brokers. The bad things that they usually do are increase the negative slippage, freeze platforms, hunt stop losses, delay executions, and fill orders at worse prices.
Hence, you have to consider whether your broker is only pushing for aggressive trading or focuses only on the development of high-quality technologies and improving trading conditions. These 4 forex broker secrets can be the keys to differentiating a good and bad forex broker.
1. Retail Market Makers
Market makers act as a counterparty to trades made by retail traders (b-book brokers). If you trade with the market makers, you never get to the true interbank market. They buy and sell a currency continuously at an openly quoted price in the OTC market. In other words, a retail trader buys a currency while a market maker sells, and vice versa. It is also important to note that a market maker always counters against the crowd and provide liquidity to any traded asset.
Then, how does a market maker get a profit? It generates a profit from the difference between the bid and ask price, known as the spread, or is compensated by a markup to the bid and ask price. Therefore, a market maker can provide liquidity. The price quoted by a market maker is based on the law of supply and demand.
A market maker just ensures a smooth flow of price movement. It doesn't intend to predict the direction of price movement or push the market towards any particular direction through the accumulation of positions. In addition, a market maker would have clear rules of engagement in which they are prepared to make a deal at offered prices.
Market Makers Are Not Bucket Shops
Because of their indirect execution, market makers are often confused with the bucket shops. A lot of traders can't differentiate between the two and end up putting them in the same category. To clear things up, here is the full explanation.
Bucket shops are brokerage firms that have conflicts of interest with their customers. The brokerage firms encourage the clients to take on substantial leverage. They can recruit new clients from the gains advertised by the bucket shop when clients profited on their trades. In the end, the clients would always end with large or even total losses. It's not a surprise that they usually want to derail clients' trades and eventually lead them to losses.
Being regulated in respected jurisdictions doesn't automatically exempt brokers from being a bucket shop. You can recognize it from two or more of the following criteria:
- The broker trades against clients' best interests (e.g. asymmetric slippage, confusing dealing prices, unreasonable last look times, ignores/re-quotes/cancels deals without a specific reason).
- Cannot match to send the majority of their unmatched volume to a real market.
- Gets profits directly from client losses.
- Processes withdrawal requests for more than one business day.
A Matter of Transparency
In a range-bound market, a market maker has plenty of time to cover its trades by passing on the risk to another trader who may have an opposite view about the trend. However, it will not happen in a volatile market. Thus, a market maker can use several methods for mitigating the risk. For instance, hedging with one or more tier-1 brokers.
Oftentimes, the transactions are done anonymously. The origin of the buyer/seller is not fully revealed until after the ticket is complete. But there would be a record of these transactions that all parties involved can have access to promote transparency. It's an appropriate way to make a market includes emulating real market price feed (from the prime broker) and provide instant fills at prices or quoted size (clear rules of engagement). You hedge to a larger wholesale market, raise spreads, etc. as necessary to control risk.
In practice, a market maker spreads and execution speed should duplicate that of what would happen on an exchange or ECN (in some cases being even better, faster, and/or with larger size) with tighter spreads.
There's a good quote from the latest ESMA Q&A that provides guidance on what EU regulators should focus on to improve markets:
"If a firm offers speculative products and acts as the counterparty to a client without any hedging arrangements, It has no incentive to execute orders in the best interest of the client because there's conflict of interest, if the client 'wins', the firm 'loses'. Therefore it should be avoided, by not adopting such a business model."
2. The Truth Behind ECN/STP Brokers
About 98% of the so-called NDD (non-dealing desk) brokers out there are actually retail ECN/STP brokers. They must send every single transaction to another entity for execution. Also, they can advertise and still profit from the losses of traders. You can usually identify these brokers if they offer ECN/STP accounts with offers like percentage of bonuses on deposits, fixed spreads, high leverage, zero spreads, and so on.
There are only about 2% of the total number of all brokers around the world that are fair. They are Direct Market Access ECN/STP (a-book brokers). These brokers will send all of your trades to the interbank market without any conflict of interest. These brokers have more liquidity and do not perform any artificial interventions to their clients' trades. Their profit is only from the spread or commission. So, they can help traders as much as possible and their main goal is long-term profitable traders.
3. Bonus Schemes
To attract new clients, a broker usually offers an incentive for trading a.k.a bonus promotions. However, the schemes are so convoluted at times that clients would rarely end up with the expected advantages. That is because the brokers would also try to maintain their benefits despite the seemingly generous offer in their promotions. There are different types of bonus offers out there:
No Deposit Bonus
Normally, a trader will get a bonus after funding their new account. But in the context of "no deposit bonus", a trader must not deposit to the new account. Therefore, this type of bonus is the most lenient one. Yet, there are requirements to be fulfilled before traders can realize the no deposit bonus. Normally, a trader has to trade with a certain number of volumes before withdrawing the profits derived from the no deposit bonus.
Therefore, before you take the no deposit bonus offers from forex brokers, you have to consider the requirements. Brokers would not just hand out free money to new traders if without making sure of their benefits. Make sure you are okay with the requirements of this type of bonus before you sign up.
A "welcome bonus" is free money offered by a broker to attract clients to sign up. This type of bonus makes a client feel welcome and to make it easier to start trading right away. Yet, this type of bonus is different from the no deposit bonus. A welcome bonus requires a deposit from a trader for getting this bonus. If you want to get a welcome bonus, make sure you agree with the bonus requirements before you sign up.
Deposit Match Bonus
The "deposit match bonus" is free money that will match a trader's deposit and up to a certain maximum amount of money. This bonus typically has a minimum deposit requirement, a maximum limit, and the broker matches a trader's deposit at a preset percentage, typically ranging from 30% to 300%.
For example, 30% bonus program will be available in proprtion to your deposit amount. But the bonus amount itself can't exceed $5,000. So, you will get an additional $300 from the broker of you deposit $1000. You can get the maximum bonus of $5000 if your deposit amount reaches $16,667 ($16,667 * 30% = $5,000). But you can't get higher bonus amount even if your deposit is higher than $16,667.
Bonus schemes from forex brokers have some requirements regarding how much your initial deposit should be or how much you need to trade if you intend to withdraw profits. The requirements may be okay for some traders, but some others may see them as a source of frustration. Moreover, a bonus might not make a big difference in the long run. It can even make things more complicated if you can't really comprehend the rules.
4. Watch Out for Scammers
Scammers are a special category of forex brokers. This type of brokers often have problems with withdrawals and doesn't really have a clear identity or legality. Unlike the previous cases of market makers and the bucket shops who trade against the clients, scammers don't look for clients' longevity. They are usually cash grabbers who quickly run and dissolve their business after earning some deposits from clients, only to open another scamming business under a new brand. This is how frauds work, so you should really be careful with this kind of brokers.
See also: Recognizing Forex Broker Scams
Weighing On Brokers' Qualities
Nowadays, the forex market is practically a technology-based market. All the players practically depend on technology. Therefore, we can divide good and bad brokers based on the presence or absence of advanced technology. If a broker has state-of-the-art technology for trading, their presence as a leading brokerage would be undeniable. The presence of technology unbinds the broker to choose any scheme of work, while the absence of technology limits the broker's choice to any scheme of work.
As previously mentioned, forex brokers are divided by specific terms: A-book and B-book. In detail, A-book is where orders go directly to the market, while B-book is where orders remain in the company. A-book companies usually get profits from the spreads and commissions, whereas B-book companies get profits from a financial outcome (everything that a trader lost, the company gained, and vice versa).
Both schemes have pros and cons:
Bad brokers either do not have an A-book or have a very low-quality one. Therefore, there are several ways the company work with a trader:
- The most loyal option: If a company doesn't have a high-quality A-book, the trader's quality of execution decreases sharply and there's a high risk of breaking the trader's strategy.
- A less loyal option. The earning client will be aggravated by the company introducing artificial lags or slippages, regular re-quotes, or rejects. This indicates the company uses B-book.
- A disloyal option. The terms and conditions include paragraphs that declare about the abolition of transactions with a duration below a certain length of time or profitability below a certain amount of points. It will be a disgrace to the industry.
The most disloyal option is an example of fraudulent companies. They collect plenty of clients' deposits and then disappear with some irrational reasons. They can declare a fraud or delete all transactions and then say that they never existed.
A good broker has a high-quality A-book. It provides good execution for clients, which determines the success of a broker. It does not artificially aggravate conditions for clients so there are many long-term clients under their service. They can measure average spreads, the speed of executions, and assess the quality of execution.
Let us look closely at this category of brokers. A company with advanced technology uses one of the following two schemes:
- The company is hedging all clients. This scheme is used by conservative companies that favor stability over large revenues. They favor this scheme because the company doesn't face trading risks.
- The company is not hedging all clients. This scheme allows fast growth but carries some trading risks as well. On the one hand, this scheme offers good executions. On the other hand, if a trader makes money using a strategy that is very sensitive to the quality of execution, then the strategy can crush in a hedge. Most importantly, the broker will not interfere with a trader's account for making profits. At worst, the trader will be hedged, but it will not prevent him from earning a lot.
Finding the best brokers can take a long time if you don't have the right tool to help you. The Broker Finder is available to assist you in selecting the most ideal broker based on your capital and trading skills.