Dealing Practices

Next to safety of funds, a firm's dealing practices and the execution on your trades is the most important thing. Just like anything else, all brokers differ when it comes to execution and you need to make sure that the execution and dealing practices of the broker match to your trading style.

When you are talking about dealing practices, you need to take numerous variables into consideration. These include, price feed, dealing desk, banking relationships, net capital, platform, order type and execution.

The tricky thing is that you can not look at each variable stand alone they all play of each other. The best thing for you to do is determine your trading style and make a list of exactly what you need to accomplish and than work to find a forex dealing firm that will most closely match your requirements. Of course keep in mind that nothing will ever match your requirements perfectly. No firm will ever match your desires perfectly; you just need to take the best fit and work around it to create your trading set up.

Obviously some firms you need to fully steer away from based on their dealing practices capital requirements and platforms. A good introducing broker that works with multiple platforms is a good resource to use. You don't have to pay anything to the introducing broker the dealing firms take care of them on the back end, however one thing to keep in mind is that he may be biased to sending you to firms that pay the most to him.

The good thing is that now days most firms pay the same to the IB but its still good to ask so there are no issues.

Many people are scared by the dealing desk and they assume that there is someone on the other side sitting there and just looking to get them on every trade. In many cases this is true. I have seen many horror stories, like dealers getting into clients positions and manually exiting trades, slippage, re-quoting, dealer intervention and much more. What you need to keep in mind is that it's not the fact that there is a dealing desk that this happens; it's the way a desk is run. Market makers exist in all markets, even the NYSE. They have to take all trades.

The way they make money is that most traders statistically are wrong and the market maker has the advantage of the spread. This is called the auction/specialist market type. A solid market maker internally matches all orders and hedges off the net position if it becomes too large. This is called the delta hedge. With this strategy, as many buy and sell orders are internally matched as possible with the market maker picking up the spread and the remainder is hedged off.

Here's an example of a popular ECN platform called Currenex.

Now with ECN models like Currenex, Hotspot FXI, Lava and a few others this can be done electronically. With the ECN platforms, banks and institutions provide liquidity into a platform which shows the best bid/offer prices available. These platforms charge a commission for the service. The benefit of an institutional platform like this is that you can trade in between the spreads, make your own market, scalp freely, and get tighter pricing. The only thing you need to realize before you start banging away your trades is that there is still someone providing pricing to you at the other end of the trade.

Going back to my poker game analogy, if there is a guy consistently beating everybody at the table or using an unfair strategy the other players will leave and not want to play with him or complain to the casino. So if a certain trader is using a trading method that is hard to hedge off or match up internally for the liquidity providers even on an ECN platform. They will still complain to the FCM and than the FCM will be faced with a decision; who do I want to keep on my platform UBS or you? What do you think the answer will be?

So if you are using a particular style that may be difficult to maintain for the counterparties -- regardless of desk or no desk, you need to come in under the radar and set your trading up properly so you do not get kicked out. Once again a solid introducing broker should be able to help you with that.

Another thing to be careful of is some firms claiming that they do not have a deal desk when in actuality they just routing all trades to another firms deal desk and getting some profit sharing. So you need to conduct some very diligent research before you pick a firm.

The first step is to identify the players involved. There's you, the client; there is the dealing firm you are using (FCM) and there are banking/prime brokerage relationships of the FCM.

Here is the way it works: you make the trades with the FCM using your online platform. The FCM matches your trade with another trader, trades in the same direction with its liquidity provider (bigger FCM/Bank) or takes the risk on itself.

With an ECN model your trades are straight through processed to the banks/liquidity provider, or internally matched with other traders electronically.

"So what's it to me?" you may ask. Well it could literally be the difference between success and failure depending on your trading style. First of all you need to classify your trading style and determine how susceptible you are to execution problems. Trading styles like trading around economic releases, scalping, and trading styles that push your margin limits are susceptible to execution problems.

I have seen firms close winning positions on traders also, but that is punishable and happens much more rarely. When it comes to slippage, re-quoting, and quoting off market there is nothing you can do but pick firms that fit your style. I will discuss sensitive styles later on in this guide.

Next you need to determine how big the firm is and what liquidity providers they use. Many firms can internally match most orders so they are never taking on the risk on you in house. Some firms have little or no liquidity providers and small credit lines and can not place trades that would hedge your trades off and are forced to take the risk on all of your trades in house.

This creates many problems, and will make them fight against you on an individual basis. If this is the case you will start getting manual execution, slippage and all the other issues imaginable. So when evaluating a firm you need to ask, if they take risk on clients positions, who they hedge their risk with, and do they have straight through processing available.

Price feed is something that you need to take into consideration as well. Most firms use various price feeds to show their clients. Price feed can work for you and against you depending on your trading style. Some firms will quote a low spread but will be always off market by 1-2 pips. This is a market making strategy that they use.

Something like this can be used to work against them. They may quote you this way because they have a forecast of the general tendency of the market and want you to overpay in that direction.

For example, if the market is going up they will always quote you 1-2 pips higher than the true price. This should be taken into consideration when placing stops or limits in a particular direction. If you know you got in a few pips above the true market you should set a slightly tighter target than you would normally. This way when they hedge your trade, they hedge it at a lower price with their liquidity provider and pick up a few more pips.

What you need to do is have an eSignal feed or a Reuters feed. These companies are independent data providers. They compile pricing from hundreds of institutions and show you the aggregate price. This price will always change quickly and is a good indication of where the true market is in my opinion. I know some traders that use eSignal as a fast data-feed and scalp of the slower feeds by some brokers. This is good to make some short term money but you will be caught and kicked out very quickly.

Another thing you should look into when you are a short term trader is how dynamic a price is. That is how many times it changes during a particular time interval. Certain firms will purposely show less movement to eliminate short term scalping. The bottom line once you have narrowed down your firms based on perceived safety and dealing practices it is a great idea to watch the feeds.

When it comes to dealing practices the STP or ECN models are the best in my opinion. Bigger firms that have been around longer are also better to use than smaller shops. You should also look for firms that have solid liquidity providers to hedge trades with and firms with a good price feed. Next >