In Price Action Trading Strategy

The sell side of the retail Forex industry can be as opaque as the market itself, and few individual traders actually have a clue about how they are being quoted, if their trade is going out to market, and a slew of other concerns that escapes common knowledge. Today we are going to cover retail broker models, common terminology and essentially everything that many brokers don't want you to know. Most of the articles found on the internet, well, most retail traders won't even look at. That is why I'm posting it here, to hopefully better educate the masses and shed some light on a typically dark subject matter. To some of you, this is nothing new, but to others, I hope to better inform.

Transaction costs are a huge concern for us because it is essentially money down the tubes and most of the time, for no reason whatsoever. This is the main reason we largely abandoned a major ECN and went with another that does not attempt to add costs on top of our preexisting PB fees.

The bottom line is that no trader should be paying anything more than around a pip on a EUR/USD during any standard trading session. And yes, on ECN platforms, that includes commission. If this is the case on your platform, then you are essentially donating money to your broker. Again, this is your hard-earned money simply being handed over to someone else, one little trade at a time. This cost can of course be justified if you are getting some serious analysis or tools in return, but most of the time this is not the case and these tools can be acquired elsewhere for much less.

Standard Retail Broker Models and Why Everyone Hates Them

Retail brokers typically fall into several “model” categories, with the larger ones using a combination of these in order to cater to more sophisticated clients. An example would be 70% B-Model, 20% A-Model and 10% C-Model being used within one firm. These are all industry terms and nothing new. Again, I am simply just bringing these into the light. So let's talk about these models one by one:

A-Model: In an A-Model, a broker profits from spread only. Trades are passed out to market via straight through processing to a bank or an ECN through a bank. You will never hear me recommend trading through any platform that does not strictly follow an A-Model. Trade matching technology is simply too good and accessible these days to have to deal with anything less.  In addition to better execution (which is an understatement), as a client, you don't have to deal with any of the more common trading restrictions seen elsewhere.

B-Model: The most common, for a reason. One look at a retail broker's client book and the profitability results are astoundingly clear: it makes much more sense to “hedge”, or trade against your client's positions as opposed to simply passing them out to market and capturing spread. Additionally, a lot more “flexibility” is given to the broker which in most cases, is a conflict of interest with the client (more on this below). Recent CFTC reports indicate that approximately 70-80% of retail client volume is unprofitable. Most retail brokers follow a B-Model simply because it is so lucrative to do so. The largest brokers here in the US have historically followed a B-Model with “good” results (understatement of the century). For clients, B-Models are generally frowned upon, yet encouraged by brokers with the argument that better flexibility is afforded to them. The major cause of concern is of course the conflict of interest and now long history of unethical practices exercised by brokers under this model.

C-Model: More obscure and essentially anything that does not fall into the first 2 categories. C-Models consist of a range of strategies designed to typically balance extracted profit for a broker and client satisfaction.

Liquidity Aggregation

Retail brokers will pull liquidity from any number of major destinations. In the early days of retail FX, the only route to go was to set up a relationship with a bank, or several banks, and pool that liquidity onto their platforms. The broker could then take their route of choice, which usually entailed market making. Today, a number of different methods may be used including turnkey solutions with established sources of liquidity or connecting directly with an institutional ECN. Regardless, a bank's services are still needed in order to hold the account and facilitate a number of operational functions.

Liquidity aggregation is getting more and more accessible these days, with a number of market participants (funds, brokers, you name it) using platforms such as MarketFactory to direct multiple trading venues into one platform on the client side. These technology improvements allow further flexibility for brokers to expand their horizons and offer better conditions for traders of all sizes. Ultimately, the market is improving, transparency gaining traction, and retail traders have more options than ever.

As it stands today, retail brokers will access liquidity by any number of different means:

Direct bank relationships: Single bank platforms or other pass through systems that allow retail FX brokers access to a wider pool of liquidity.

ECNs: A relationship with a larger bank is usually required as well due to the broker's lack of size, thus credit.

3rd party aggregators or all in one solutions: These businesses essentially act as a turnkey solution for everything when it comes to starting an FX brokerage business. Leverate is a prime example. Companies go to these types of businesses for simplicity and negotiation muscle when it comes to acquiring liquidity for their shop.

And Now for Some Badly Needed Explanation of Terms:

ECN: Electronic Communication Network. ECN's have risen in volume substantially over the years and will likely continue to do so, as they have several major benefits:

  • Direct access to liquidity: It is you and the bank / another trader / institution, whoever wants to make a price.
  • Deep liquidity: Prices are abundant on the majors and can generally serve most of the more demanding clients.
  • Limit Book Access: Orders are out in the open. Conventions do indeed vary from ECN to ECN.
  • Superior execution: Due mainly to the above. Note that some platforms will still allow for “last look”, giving the counterparty the upper advantage on your trade.

Retail brokers commonly advertise ECN platforms, but this does not mean that they are a “true” ECN. A “true” ECN allows direct access to the interbank market, where the broker charges you a commission on top of your spread, which even can commonly be inverted. Many “ECNs” labeled in the retail world still pose risk to the client. These are not “true” ECNs but usually a bridge of some sort where spreads are marked up and inventory risk for the broker is still a concern. Major institutional ECN's include Currenex, FXAll, Hotspot, LMAX, etc.

An ECN broker will allow you to trade directly with other participants in the marketplace. You are literally trading on the ECN with the rest of the world, consisting of banks, hedge funds, other individual traders like you, etc. Be aware that some ECNs are only as good as the platform you are using, so ensure you picky in terms of what software you choose to use.

Market Maker: A market maker typically does several things:

Creates a price for you, the client. These prices are most oftentimes “representative” of a true market price and in some cases, your trade will never even leave the retail firm. The market maker will take the other side of your position, sometimes determining whether or not you are an A or B client. If you are an A client, in some cases your trade will be routed out to market, essentially making you someone else's “problem”. This can still cause major issues in execution, however, as your trade is jumping a few servers and usually old technology to make it happen. If you are a B-client, the broker essentially has confidence that at some point, you will wipe yourself out and fork over your money to them.

The vast majority of retail forex brokers follow some sort of market making model. It is still very dominant and allows them the pure flexibility of doing any number of different things, which most people with half an ounce of common sense would consider unethical. Delaying execution, utilizing trading restrictions and popping spreads around stop losses so they are executed are just a few examples of some of the horrendous things these firms are capable of doing. And yes, some of the largest shops will do this. Plainly speaking, it is difficult for some regulatory agencies to detect some of this behavior, such as “spread popping”.  If you want to avoid any of these things then simply stay away from this model. Regulatory agencies will only catch so much, but they are getting better at doing so.

Much of the above described activity is simply illegal in most jurisdictions, but that has not stopped many brokers from doing it. Those who have been caught are usually done by a well-organized regulatory entity, such as the NFA.

The much, much greater majority of brokers who find themselves in trouble do so because they are playing around with the market making model. Granted, not all market makers are “bad”, but the possibility for them to be is much, much greater than those following an A-Model.

Retail traders are becoming more savvy to these tactics, of course, and opting against these types of subpar trading conditions. So it is no surprise that a slew of other services are offered by brokers in order to entice newer traders to come on board.

DMA: Direct Market Access. Just as the name implies. You, the trader, has direct access to the interbank market. This entails you accepting, or if allowed, making a price with any number of counterparties available on the platform. The term is commonly used in conjunction with an ECN model.

STP Straight Through Processing. – Another term that gets tossed around quite a bit, which gives some indication, but not all, as to what model your broker is following. Straight through processing implies that your trade is passed through the broker, direct to their liquidity provider(s). The most common way of distinguishing an STP broker from an ECN broker is that an STP broker passes your trade directly to banks in which they have a relationship. An ECN broker will pass your trades to a true ECN, where you have complete access to a range of participants.

The broker will inflate the spread in order to profit from your transaction turnover and “make up” for the lack of B-Model being employed on your account. They want you to be profitable so that you continue to rack in commissions, but make it extremely hard to do with such high costs. Some of these markups are extraordinary, however, and the concept is laughable. Essentially you are being charged for the “courtesy” of the broker not messing with your trade execution.

Some STP's are certainly more reasonable and offer better markups, or lack thereof. To my knowledge not one “reasonable” STP exists here in the United States that will offer fair costs and pure execution without restrictions, such as severely inflating spreads, etc. STP is still limited, however, in the sense that someone essentially has an upper advantage over you, to state it in general terms.

No Dealing Desk: An “overused” term that gives vague indication as to what the broker is actually doing with your trade, though generally refers to some form of STP. This is thought to imply that the broker is directly following a pass through system, though manipulation with conditions is certainly still possible.

Signs of a Market Maker or “Fake” or “Quasi” ECN aka STP

  • Requotes on any trade. On a true ECN you get a price and take it or leave it.
  • Prohibit any type of trading such as “scalping”.
  • Asymmetrical slippage. This an illegal practice here in the US (and abroad I am sure) where the broker does not give you the benefit of the doubt should slippage be in your favor, yet make you suffer the loss if slippage is against the intended direction of your trade.
  • Hide depth of book. Trade volumes should be visible across the platform.
  • Set freeze levels. Freeze levels are minimum distances for stop loss or take profit orders.

This list is primarily geared towards market makers, many of which have conducted themselves in manners which, well, let's say I highly disapprove of from an ethical standpoint.

“Fake” ECN's or other forms of STP I do not consider always bad, but I don't consider them the best, either. For most retail traders, they will do the job yet be aware that you are still likely to face restrictions not seen by those trading on a true ECN platform.

Some people prefer STP over ECNs in terms of execution speed, as I have heard it is claimed to be better. The bottom line is that when you are getting this technical you have entered a world where much of our discussion here becomes irrelevant.

Getting Access

As previously stated, most brokers offer some form of direct market access, yet they require you to be a “Pro” client, or whatever naming convention they use, in order to get this kind of access. This typically refers to large deposits or large turnover. As this market continues to evolve, more and more brokers are popping up and filling the void in order to grant such access at a very basic level.

The problem tends to arise with white label solutions, usually delivered by firms like Integral or Currenex, which can demand higher requirements. Others have brokered deals where the aggregate volume gets routed in order to compensate. Currenex Standard and Viking, and platforms like it, are being offered to retail clients with large deposits through many brokers.

LMAX is a prime example of a new kind of ECN designed to squash the old retail market making model. For anyone based outside of the US, accounts can be funded with as little as $1,000 through an introducing broker.

For the rest, an ECN is an ECN. Institutional or retail, you still need someone to hold your money and do your paperwork/settlement. That's where your broker steps in, and things tend to get a little murky. Most brokers will charge a simple commission based on some form of tiered volume schedule in order to make money on your trades. Others like to fiddle with the volume. Personally, I don't mind paying a commission for the lack of conflict of interest.

US-Based Clients

As usual, US clients have somewhat of an anvil tied around their necks due to the indirect effects of recent regulatory actions. Like the largest banks after the financial crisis, most of the smaller FCMs ended up consolidating with certain houses in order to meet a number of regulatory requirements. Additionally, costs vs. profit became exceedingly slim, forcing many UK-based firms to hand over their U.S. books to these other U.S.-based brokers with already larger ones.

Unfortunately, most of these larger brokers historically utilize unwavering B-Models unless you walk in the door with $10,000-$20,000 and access a “Pro” account, or face an uphill battle against inflated spreads on an STP model. As a result, setting up a penny practice account on an institutional grade execution platform is far from the easiest bet. If you are able to do this, then no questions asked, pay the commission and get the dirt cheap spread. Also, I recommend going with a company that has a leg in the institutional world (the real one, not wannabes) as opposed to what is stated on their website.

My Recommendations

Transaction cost comes first. Save your money. Those little, incremental amounts add up substantially over time. Experienced traders know this, newer traders see it more of a non-issue. It is a HUGE issue.Do your homework. Sites like http://www.fxintel.com/ can help steer you in the right direction. And no, demo spreads can be very different from live spreads.

Do a due diligence/background check to ensure that no massive red flags have risen in history. For clients based in the US, http://www.nfa.futures.org/basicnet/ is the place to go. Australia, this way please: http://www.asic.gov.au/asic/asic.nsf/byheadline/Introduction+to+ASIC+Connect?openDocument and the UK, right here: https://www.fsa.gov.uk/register/home.do . For firms based in any other countries, I simply don't have enough experience dealing, but I can say that these 3 have some of the higher regulatory standards in the world.

For the NFA, simply type in the name of the firm, hit “GO”, and look in the “Regulatory Actions” box. Have fun.

Also, if you can't find dirt on a firm in one country, they might be registered in another as well. Stay clean. That's my best advice.

Find out what kind of model your broker is using. Again, many larger brokers now offer A-Models in addition to their traditional B-Models. You want to get as close to the market as possible and with as little interference necessary, and at a reasonable cost. If they refuse to tell you, then 99% of time they are B-Model. An A-Model broker would have zero problem disclosing information about what happens to your trades.

Most people slip when they call a broker, ask if they trade against client positions, and are given the ring-a-round to the no dealing desk “model” where they end up being eaten alive by either poor technology or inflated costs. So be careful. Just because a regulatory agency is watching your broker does not mean they are up to no good. Just a couple weeks ago, the FSA went after one of the largest retail brokers in the world because of asymmetrical price slippage. This broker has been in business for years and yet such conduct is still prevalent. So do your homework. The landscape is changing and people are becoming wiser. There is no need to settle for less.

Other Final Considerations

Stay away from any form of fixed spreads. These simply don't help. The broker is either a market maker or using an STP that will work against you when you need it the most.

No platform is perfect, whether they be a market maker, STP or ECN. Again, research.

Find the biggest pool of liquidity you can. A whole world opens up to you. Want to trade spikes? No problem. Want a fill in a few milliseconds? No problem. More liquidity typically translates to lower spreads and while the flexibility might not be needed today, it likely will in the long run.

If you intend on investing anything greater than 10-20k, your options open up substantially. Use them.

Be smart. Choosing a proper broker should not be a rush decision or one based on tools, signals, or any other type of vanity that is essentially the FX world's version of a free buffet at a casino. It's your money. Keep it safe.

Please post any comments below but all I ask is that you take it easy with the names. This article is meant to inform, not bash others. Thank you.

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Showing 27 comments
  • Albert
    Reply

    I currently have a live forex account with OANADA in U.S which, I think, fits into ‘A-Model’.
    However, I’m a news trader and their spreads go up all the way up to 20~30pips, or even more at the times.
    I usually wait until the spreads go back down to 2~3pips, but then again often times ended up missing tradable chances.

    Is there any good brokers which you have come across which you think it’s worth to try, that fits into ‘A-Model’
    who provide fixed spreads?

    Would you recommend me one or two good ECN fixed spread brokers in U.S, please?

    Thank you in advance.

    • Steve W.
      Reply

      Right, they’re going to fall into the STP category. You don’t want fixed spreads because you will never get executed at a good price on those spikes – market makers are the only ones that are going to use fixed. They will either requote you or execute you at a terrible price. Your best bet is finding an ECN, preferably with very deep liquidity and direct access. Your spreads will inflate but only to a few pips. Spreads inflate when inventory risk is high. That’s normal. 3 pips is obviously better than 30 though. If you are outside the US you have a lot of options. If inside the US, not so much. I have no idea what your account size looks like but the more money the wider the option gate. You can also look at brackets on futures. That’s a whole other discussion.

  • Jim N
    Reply

    Thanks Steve for taking the time to help us along in this adventure. Why I have been trading for a while, understanding this portion of the business has been like Vodoo to me. I certainly need to understand what is behind all these models. If/when i make a jump to a larger account, i want to make sure i am certainly on a level playing field. My biggest concern, however, is a PFG Bankruptcy scenario where accounts are not segregated. Don’t want to live in fear, but this scenario is the one that could really sting me. On another note, i need to tell you that i am starting to “get” what you have been posting and teaching. I have really discovered the value of TL breaks and how to trade them. THanks again for all your helps.

    • Steve W.
      Reply

      You’re welcome, Jim. And you are justified in your worry. Again I stress the research component. The internet is there to help you along. Just google what’s discussed here to get more details and find your new “home”. But I hear you loud and clear. Great to know about your learning curve as well. Keep us posted.

  • Brad Furman
    Reply

    Is it advisable to use a broker from the UK or Australia if you are a US resident?

    • Steve W.
      Reply

      The way I have always been told and understand it, it is a resounding no. Number one the greater majority are not likely to accept you as a client. Number two, or at least the way I interpret the law, it is not legal for a US person to do this. Offshore corps, etc., are basically just a form of beating around the bush. I think we would all love to. So many better options offshore.

  • Alen
    Reply

    Steve, a quick question. What do you personally thing of the FXCM? I dealing with FXCM UK… Have read and heard a lot, but would like to hear your opinion.
    The reason I’ve chosen them is that they are big and on the market for a longer time. Not likely to disappear overnight, but they do have their own tricks… Thanks!

    • Steve W.
      Reply

      Hi Alen, I would just recommend looking at your criteria in tandem with everything listed above. FXCM is one of the companies with a “pro” account, and I know they started some kind of ecn themselves. fxcmpro.com looks like the site to go to, but maybe different for the UK. Platform looks like Currenex’s Classic platform, white labeled. Security of funds is a huge deal for most people and I know that is one of the reasons they continue to get so much retail business these days, but I have never dealt with them myself.

  • dean
    Reply

    Steve, seeing the ICMarkets is a partner of this site. Would you recommend them? I know you just don’t put someone’s name as a partner unless you’ve done due diligence. What broker do you use personally?

    • Steve W.
      Reply

      I would, the only thing I question is the live execution and only because I’m literally unable to do it being in the US. Good brokers are rare and so I went with choices that seemed to make sense for a number of reasons based on who comes here, their goals, and then outside responses, etc. I am probably a bad example for this but for work I trade on an aggregation platform that uses Currenex and EBS and then my own account is with Interactive Brokers.

  • Brad Furman (@bfurman)
    Reply

    Steve,

    In considering different brokers, part of my dilemma has been settling on a decent trading platform as well. I have looked at several that can be linked to different brokers like eSignal, RealTick, Ninja Trader, cTrader and SierraChart. I was wondering if you have any insight here. Part of me wonders if execution doesn’t suffer somehow if you don’t use a proprietary chart package offered by that particular broker.

    As always, thanks for all you do here.

    Brad F

    • Steve W.
      Reply

      Some platforms are notorious poor performers, like MT. I have become more and more anal over the years about execution because I have learned what a massive deal it is when you need it the most. If you want my honest opinion I find the less focus on making the GUI look pretty or bells and whistles, the better the performer. My work platforms don’t even have charting functionality, for that reason. Quote streams, P&L and buy/sell – that’s pretty much it. Hope that answers. We were using CQG for a long time, which was fine, but not essential for what I/we do.

      • fxsave
        Reply

        to this day I still use mt4. I feel comfortable there. Is it really bad sir?

  • therumpledone
    Reply

    I have been using MB TRADING for years long before I became an IB. I am no longer an IB because CONGRESS changed the law. FULL DISCLOSURE.

    I find the people at MB TRADING great to work with and do not hesitate to steer traders to them.

  • Will Help
    Reply

    Great article thank you … After seeing that you use Interactive Brokers I went to the NFA site you linked and looked up them up. They have numerous Regulatory Actions but i don’t really know what i’m looking at. Could you please go into further detail as to why you settled on this broker as an American as i am. Thanks

    • Steve W.
      Reply

      Hi there,
      Yeah you have to read the complaints….top portions go over the basics – and yes, they are all a mess here in the United States. Probably elsewhere but they don’t get caught like they do here. IB has had a few but they are all administrative….I cut government punitive actions in 2 categories: 1 – legit and preventative of fraud and 2 – a little over the top and possibly going too far.

      The big violations for me are anything that messes with client funds. So asymmetrical slippage or any other kind of execution playground bullying tactics, etc. Most administrative I can deal with, because I have been audited as a CTA (as we all are) and I know full well how crazy it is. Retail FX is almost impossible to conduct business here in the US anymore because regulation is so fierce. The laws themselves are long and detailed. But there has been so much overwhelming fraud that something had to be done. But then I think both sides went too far. I went with IB because of the agency (A) model for a private account, and it has been fine for what I do.

  • Will Help
    Reply

    Thanks for the reply … I think i understand … Think I’ll go explore there platform … I know. I know. Not the most important thing but I’m new and want to play with all the new toys. Thanks Again

  • Bill MacKenzie
    Reply

    Hi Steve – I see that FXCM has utilized a new pricing/spread structure that seems very competitive for both small and larger accounts. They use the term NDD or Non-Dealing Desk for their model. Is this an ECN or STP broker or both? Could this be the best bet for US residents to broker with? Thanks Bill

    • Steve W.
      Reply

      Hi Bill,
      Yes I saw this last week too, and from the looks of it its a straight ECN – definitely a welcomed change. I haven’t done all my homework on the exact model they’re using but the structure has all the signs of one. I dont know why they would even use the NDd lingo because personally, it comes off less sophisticated but maybe that’s what they were looking for from a marketing perspective. Not sure.

  • Izzat
    Reply

    Hello Steve,
    I noticed that IC Market is no longer listed under recommendation. I you don’t mind, care to share why?

    • Steve W.
      Reply

      Hi Izzat, Not sure what you are referring to there. Nothing really changed. I changed some layout things around here a couple weeks back but that was about it. Thanks,

      • Izzat
        Reply

        Yeah, sorry. Just went & check out the recommended broker page again & its there. A problem of my browser not loading everything properly.

  • Pete
    Reply

    FXCM UK was fined for asymmetrical slippage just last year. Can they be trusted to run an ECN model legitimately I wonder:
    https://www.fca.org.uk/news/fca-fines-fxcm-uk-4-million-for-making-unfair-profits-and-not-being-open-with-the-fca

    btw great info Steve as per usual.

    • Steve W.
      Reply

      Hi Pete, I remember that. FXCM’s retail business is still not a true ECN although they advertise no dealing desk, which can mean many different things. My guess is some variant of STP, like OANDA has been using from day 1 but obviously not apples to apples or they would not have been punished like they were after the EUR/CHF peg removal. They had FXCMPro, which was literally just sold after they got wiped out by the EURCHF debacle. Like Gain’s GTX, their true, pro ECN was catered to compete with the likes of FXAll, Integral, etc. No idea what the fate of it was as I’ve never personally used it http://leaprate.com/2015/01/fxcm-set-to-sell-fxcmpro-leaprate-exclusive/

  • Ronald Artienda
    Reply

    Hello and aloha Steve

    I’m using forex.com who’s parent company is gain capital which profited during Swiss bank crisis on their currency this year removing the floor on the Swiss franc? I choose them because of it

  • Jan
    Reply

    I’ve been observing the transaction costs this week and noticed that on cTrader the commission are pretty high, for an example on cable prior to Brexit was €10c which is already above 1 pip (0.09€) and we haven’t even come to spread. My August was like +90 pips but when substracted by costs it’s like -2.73€ (on a 1k lot). Disturbing.

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