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Trading secrets from one of the biggest brokers in history

Everyone knows the stats. Retail traders tend to lose...

Everyone knows the stats. Retail traders tend to lose.

Brokers understand this, so will often take the other side of the trade.

So, if brokers tend to win…

Why not trade like your broker?

I still find it staggering that most traders don’t understand the broker business model.

It’s like turning up at the poker table, deciding that everyone there seems perfectly lovely and thinking this will be a pleasant & enjoyable experience for all involved.

Know your counterparty!

Most of the time, the broker is your counterparty.

Which means you go in the B book until/unless you cause them enough pain that they don’t want to play with you any more.

Related: One of my favourite ever podcasts interviewing Betfair co-founder Andrew Black.

N.B Betfair only exists because ‘Bert’ was too good for the bookies and they stopped taking his business.

If we want to understand a broker, we need to hear how they think of us, the traders…

This is titled Risk Management lessons for Retail FX/CFD brokers Part 1

I’ll reveal who wrote it at the end (and annotate as we go):

Proper data analysis is the beginning of this journey.

Most A/B book decisions are made on absolute value of realized P/L.
Most brokers simply take very profitable clients and move them to the A book. This is a terrible idea.

He’s right. Brokers are only human. So if you’re costing the broker too much in absolute $ terms they’ll want to send your trades right out the door for someone else to deal with.

Usually labelled as ‘toxic flow’ internally, but one man’s trash is another’s treasure so the broker can farm that flow out to another dealer (A book) and still make some $ without taking the other side directly.

Which brings us to the next points…

Few clients are very profitable and many that are, are LUCKY due to market conditions being range bound and don’t belong on A book on a consistent basis.

Absolute P/L as a standalone measure is also a backward looking indicator that will drive most people crazy trying to time the market.

Automated Tools exist to properly sort A and B Book on whether clients are lucky or likely to repeat performance and if clients are just winning due to range bound markets.

Much like a trader who’s been wrong for so long, a broker might use the absolute P/L value and erroneously A Book a trader that’s just about to give it all back…

Terrible business for the broker. Locking in the losses and no chance of the gain.

Now, if you’re a particularly skilled trader & you know that brokers tend to think in absolute P/L terms, it makes sense for you to try and split your trading between various venues.

Staying on the B book often gets you better trading conditions…

So you use a copy trader/Expert Advisor and spread the orders.

Tools also exist to detect patterns of EAs/copy traders that are costing you money, making sure those clients can be moved off the B Book in a timely basis before too much money is lost.

Gah, they’re onto you. Although not every broker uses tools to detect this…

So, who’s the WORST client for a broker?

Other factors to consider are the many clients with high volume but no real P/L impact one way or another, specifically those that have IBs/affiliates attached to them.

These clients tend to be the most expensive to most brokers.

Stop and think about this: If the broking model was truly “make money from commissions”, these would be DREAM customers.

Churning their accounts & constantly getting in and out of the market means a commission (or spread) bonanza on every turn.

Yet here’s this highly experienced guy telling us that they’re the worst clients (especially if they’ve got to pay a % of comms to introducers or affiliates)

Key point then…

Just like trading, managing a book is hard.

Plenty of brokers fail where they just middle along, not really making the deep pits of cash they thought they might…

What’s the solution?

While consistently timing the market is a low probability event, knowing strength/velocity of potential moves based on client positioning at your firm/peers as well as real data from the institutional market, brokers can better hedge or set risk for major events or when positions pile up in one direction.

While not an exact science, determining market regimes in (daily, weekly and monthly) increments can make a big difference in most brokers P/L. 

While that advice is aimed squarely at brokers, tell me it doesn’t apply just as much (or more) to retail traders and I’ll call you a liar.

Look at market regimes, understand when they’re shifting. Has the current trend over-reached? What’s the positioning like? Is it one-sided (stretched)?

Is the market trending or rangebound?

(did you note the earlier comment about retail traders being more profitable in rangebound conditions?)

Just in case it’s not obvious. Your broker is your counterparty. And this is the advice they’re being given:

While not an exact science, determining market regimes in (daily, weekly and monthly) increments can make a big difference in most brokers P/L.

Guess what that means for your P&L…

Likewise, if the broker is identifying whether you’re actually an excellent trader or simply good in certain trading conditions (e.g. rangebound) then maybe, and I’m just putting it out there, any trader should do the same exercise?

Trimming the fat: The broker will depend on you giving back all of that P when the regime changes. So, stand aside, or identify the shift and change your trading style.

All of the quotes above are from a guy called Drew Niv. You might not know the name, but he co-founded FXCM back in 1999. The company revolutionised electronic trading for retail customers & brought FX to the masses.

Back in 2017, FXCM was fined $7 million & banned from operating in the US after the Commodity Futures Trading Commission found the retail currency broker had an undisclosed interest in the market maker that consistently "won" the largest share of FXCM's trading volume - and thus was taking positions opposite its retail customers.

The guy knows his stuff.