All your losses the broker’s profits, and does it really matter?
Is the broker your friend or enemy?
A lot has been said about the Forex market and the involvement of the broker.
I'm sure you've heard the conspiracy theories that the broker is out to get you, and the broker is always looking to see where you've placed your stops in order to stop you and make you lose money.
So is this true?
Before we answer this question, we need to explore the different types of brokers, how they're structured and set up. There are two different types of brokers.
You've got what are known as the A book broker and the B book broker..
A Book Broker
A Book Broker funnels your trades straight through to the interbank market and matches your trades with another trader somewhere in the world. A Book Broker doesn't care whether you make or lose money.
He makes his commission by charging you a small fee per trade or transaction. Sometimes they even make some money by increasing the spread from what he's getting from the interbank market.
B Book Broker
B Book Broker takes the other side of your trade. Let’s say you win $100 in the trade. That means he loses one hundred dollars on that trade. As you'd expect, these brokers literally have thousands of clients from all over the world. These traders are classified in two ways.
First of all, you've got the profitable traders. That's those that make consistent gains over a period of time. Not just one big gain.
Then you've got the losing traders. These are the consistent losses over a period of time. All those traders that just come into the market with five hundred thousand dollars and want to gamble away their account.
A broker will typically know if you're likely to be a winner or a loser.
How do brokers know if you're a winner or a loser?
They employ what are known as quantitative research statisticians.
These statisticians are employed to build fancy statistical models that define the traits of a losing trader.
For example, they will look through your trading history, identify the language used, where you place you stop, the time of day that you're trading, the number of trades and so forth.
This helps them build a picture on how you will likely perform.
If their analysis deems you as a losing trader over the long term, they're going to funnel your orders into the B Book.
This means they're going to be taking the other side of the transaction. For example, if you're buying the EUR/USD, they're going to be selling you that and they'll be taking the other side of the trade and therefore the market risk.
If you make money on the trade, they will lose money on that trade.
If the quant guy identifies you as a profitable trader, he assumes you're going to make money in the long term.
The broker will then push your order through to the liquidity providers. He won't take the other side of the trade. It would be absolutely ludicrous for him to take the other side of the trade if his quant guy is telling them that you are a profitable trader over the long term.
So how does this affect you?
Well, I don't think it does.
In fact, you're pretty much unlikely to know whether your trades are going to be placed on the A Book or the B Book.
Although I guess it would be quite nice to know if you are on the B book and these highly sophisticated quant guys deemed you as a loser.
Do the B Book Brokers always make money?
No, of course not. They have their losing periods as well as traders become profitable. Usually during the trading markets. But the quant guy knows that in time you'll eventually give the money back to them. So they just let it continue.
If you were to become a consistently profitable trader over time and the gains were substantial, they would simply move you from the B Book back to the A Book.
But again, you wouldn't even know about that.
There's also another type of broker which is known as the Dealing Desk Broker or the Market Maker. These are also B Book Brokers. They wrap a price around the interbank market price and give you a fixed spread (unlike the STP brokers that have floating spreads).
Brokers will have complete discretion whether or not to fill your order.
Generally speaking, there's no commission charged with a Dealing Desk Broker, but it makes its money on the spread and your expected losses.
If the broker constantly loses money by taking the other side of your trade and the losses are substantial, he may not want your business going forward.
Knowing if your broker is a dealing desk broker dealer is quite important. Dealing desk broker is more likely to face accusations such as accusations of unfair execution because he's filling your orders at total with discretion.
Your losses or their gains. But more importantly, your gains are their losses.
This could affect the executions if you're trading with a notable size.
At the end of the day, if your broker is regulated, it's highly likely they're not going to be corrupt. They're not out to get you. They're not desperate to fill your stocks.
The true fact of the matter is, the reason why traders fail is not because of the broker, it's because of the trader.
If you've had a good or bad experience with your broker, please leave a comment below. I'd love to hear from you.