Forex trading for retail traders isn’t possible without using a broker’s service to execute orders reliably. These brokers have to be trustworthy since you give them access to everything related to your account. But you may also want to know if they trade against you.
Most Forex brokers trade against their clients. Since they act as intermediaries between liquidity providers and traders, they can keep the offers in the house and act as the other side of the trade, especially when the client doesn’t have the necessary experience or the trade is sure to lose.
In this article, we’ll talk about how Forex brokers trade against their clients. We’ll also elaborate on some other ways that brokers might cheat their clients.
How Do Forex Brokers Trade Against Their Clients?
Brokers act as intermediaries that send offers from investors to liquidity providers. But sometimes, they appear as market makers. So, when you place an order, you won’t trade with the market, and the broker plays a counterparty role.
Sometimes, the brokers decide not to send your order to the liquidity provider and become the other end of the trade. If you’re a beginner and the broker is sure you’ll lose, it keeps you in the house and doesn’t send your offers to the liquidity provider. If you’re profitable, It’ll route your offers to the liquidity provider since it’s not wise to bet against you.
Brokers may trade against their clients in two ways:
- They don’t send clients’ offers to the liquidity provider and take the other side of the trade. It’s a risk-neutral approach since they don’t keep the position long and quickly offset the trade to the liquidity provider.
- They choose certain clients, track their positions, and take the other side of the trade. These clients are typically novices who brokers decide to keep inside the house and trade against. When a beginner takes a position, the broker offsets it by taking the opposite direction of that position. For example, if you take a long USD/JPY position, the broker takes a short position on the same currency pair.
Both of these approaches can run liquidity risks if the banks don’t take positions. So, ask your broker about their trading system to make sure if they trade against you.
Other Ways Brokers Cheat Traders
When choosing the right brokerage, the first consideration is whether or not it’s registered with government regulatory bodies. While regulation ensures they won’t defraud you. It can’t stop brokers from trading against you since it’s not always illegal or noticeable.
In addition to taking opposite trade positions, brokers trade against their clients in several different scenarios. Here’s how:
Forex is known for its low or zero commissions. The only fees traders have to pay are spreads, the difference between the bought and sold currency’s price. Each currency pair has a different spread amount. Stop-loss hunting uses spreads to cheat clients.
Suppose a trader takes a short position (they predict that a currency’s value will go down). To avoid losing money, they set a stop-loss order, which allows the broker to buy or sell the position when it reaches a specific price.
When the market goes against the client’s position and gets near the stop-loss limit, the broker increases the spread so that the price reaches the stop loss sooner and before the market changes its direction. Brokers hire employees or use robots to monitor these movements and detect which prices are getting close to stop-loss limits.
In these situations, the clients think they have lost the position because they were wrong in predicting price movements. But it was the broker who triggered the price to reach the stop loss. If they don’t trigger the prices, the prices may change their direction and go as the trader had predicted.
ECN brokers use electronic communications networks (ECNs) to help their clients access currency markets. As non-dealing desk-brokers, they transfer the orders to liquidity providers, typically banks. These brokers can’t trade against the clients because they only match market participants. But they do cheat through a concept called markup.
When an ECN broker passes an order to the liquidity provider, it charges a fixed amount of commission or pip set by the liquidity provider. If it gets greedy, it adds extra pips to this base spreads and charges the client more.
For example, the broker can charge one pip for a currency pair, but it charges an extra one pip, making the total spread two pips.
To determine if the broker is charging you added markups, compare their spread for a specific currency pair and the market’s regular spread. If it’s 1-3 pips more than the normal spread, they’re adding a markup.
Some of them may even tell you they’re adding markup because they think it’s their right to charge extra pips in addition to commissions.
Some brokers take advantage of market volatility through slippage, making you lose money or not profit as much as you want. Market maker brokers don’t like you to win because your win is their loss when they trade against you. When a trader decides to buy a position, the broker increases the price just before the trader hits the buy button. So, you’ll see that the asked price on the chart isn’t what you saw as the entry price before clicking on the buy button.
The brokers try to justify these differences with volatility and market situations. That’s why it’s difficult to make sure if they’re slipping the prices or it’s just the price fluctuations.
Depending on the type of broker, slippage may be intentional or not. For example, ECN/STP brokers don’t employ the trick because they don’t earn money from your loss. The more you win, the more likely you’ll be to stay and trade with them. And they’ll keep making money from your trades.
When a trader holds a position overnight, they have to pay a swap, an interest rate for long-term investments. And the longer they hold it, the more swap they need to pay. So, be careful the brokers won’t overcharge you.
All brokers have fixed interest rates for each currency because central banks determine them through a special formula. But some brokers charge their clients higher swaps. You can easily compare the swaps with the stated prices and change your broker if it’s much higher.
Re-quoting has to do with system latencies and taking advantage of them by brokers. The broker uses system delays to cheat you or intentionally delays the trade execution to stop you from entering the trade. It’ll then offer a new price that’s less profitable to prevent you from earning more.
Suppose the prices are falling rapidly, and you choose to make a sell entry. Knowing the high profits of this entry, your broker delays the execution and doesn’t let you enter the trade. It waits until the prices get lower and gives you a new quote. This way, It doesn’t allow you to achieve your ideal position. The same happens when the prices are going up, and it gives you a higher price after the delay.
Forex brokers are the links between traders and liquidity providers. But sometimes, they decide not to send the offers and act as the counterparty to the trade. Different brokers trade against their clients in different ways.
Some of them only trade against their clients in the technical sense because they do it for a short time and offset the trade quickly. Others choose the clients, track their positions, and take the opposite direction as the counterparty.
They may also cheat clients through added markups, re-quoting, slippage, and swap.