Forex Brokers - Do They Treat You Fairly?

Forex (Foreign Currency Exchange) traders spend a great deal of time worrying and discussing their uncertainties regarding the retail brokers they engage to execute their trades. Of course it's natural to assume that making money trading Forex merely means to 'beat the market' by finding and executing high quality opportunities. Sadly, the company that any trader uses can have as much to do with how much success he has as any other influence.

Many traders stay away from what are often called Bucketshops; agencies who quote inaccurate prices, apparently play fast and loose with them to help themselves, and actively invest against their own clients. Very few companies will admit to doing such a thing, mainly due to the undeniable fact that it gives them a strong incentive to cause their clients to lose. Yet another phrase used for this type of companies is 'Market Makers'. These agencies are creating the market their clients are trading in, rather than relaying their orders out to the broader market. A hard look at the currency environment, however, shows us that such a practice is truly vital to letting small retail trades to happen, and although it As frightening as these truths may seem, small capital trades would not be feasible without there kinds of methods, and not all companies use them to defraud their customers.

The reason for this is because there's no actual 'Forex market', like there is with typical varieties of trading. To demonstrate this, company stocks are bought and sold primarily through typical stock exchanges -- the New York Stock Exchange being among the most prestigious. Every trade which are made on exchanges such as the NASDAQ is cleared by that exchange, traded according to the rules of the exchange and moved through brokers who are regulated by the exchange. Stock exchanges set the hours for business and have the authority to decide if any stock or brokerage should be delisted or suspended as the result of practices which could damage the broader market. These exchanges have real brick and mortar addresses and are in turn regulated by government agencies.

However, the Foreign Exchange market is merely the combined trading of corporations that need to transfer funds from one particular currency to another. The actual Forex market consists of huge multinational conglomerates and international financial institutions who move currency around as a way of facilitating international trade. When a Japanese company sells goods to America, it will surely get its payment in the form of USD, but it must pay its own bills in the form of JPY, so it needs to be able to exchange a massive amount of currency on a continual basis. Businesses such as this and the banks they employ to exchange the currency are the real market, and retail traders are incapable of being involved at this level; they simply can't provide the huge sums of capital that are of interest to the real currency players.

As a result a Forex broker needs to be free to trade currency directly with their customers. They will take in small trades of the kind we can do, and then they just bundle them all together. Then they make more substantial offsetting trades out on the broader market making use of arrangements they have with 'Liquidity Providers'. The large banks are able to trade with an agent who handles thousands of smaller traders even though they would not ever consider trading with each and every individual. It simply would not be possible for them.

So, a retail broker must provide price quotes to clients, but there is not any central exchange that guarantees the prices traders are given. Each broker executes transactions with their own banks and different brokers are likely to use different liquidity providers. Those disparities are seen in the variation between broker quotes. It is not a scheme to screw the customers (although there will be a few that do) but simply a necessary part of making the market for us to trade in. A broker might be ethical yet still need to trade against its customers, even though they're not planning to shift price quotes and cause those clients to lose.

So, in summary, we have seen that retail brokerages are required to take an opposing position for all but the most substantial of their customers' trades, but they should not use this to unethically work to their detriment. This sets up a significant situation of 'caveat emptor' - that is, let the buyer beware. It's important to always actively keep an eye on the price quotes and trade practices of their agency, and to choose that brokerage sensibly. It would be unfair, though, to assume that a broker who takes the other side of a client's trades is doing so to screw them. It may sound bizarre and even a trice distressing, but it is a fundamental and important aspect of the speculative foreign currency exchange business model.

About The Author:

Brian Dalton has been studying and trading Forex for years, using his knowledge and experience in the realms of science, engineering, computer programming and statistical data analysis to help him understand the often confusing and chaotic world of Foreign Currency trading. He has made it a personal goal to help fellow traders by sharing his insights and understanding to de-mystify the Forex market experience. You can read his blog at Money Pipeline. He writes and sell Forex indicators and trading systems at www.tantalusonline.com.

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