Behind every new venture, there’s a story. Of course, there are always two sides: the real business model and the motivational legend. The first involves executive “sacred knowledge." The second serves as a motivational legend for everyone else. In this article, I'd like to take a deeper look at the two sides that exist in any Forex story: the trader and the brokerage. More specifically, within the confines of Forex, how can a trader find profit and success?
I'd say the magic happens, as always, on the borderline. It occurs when you get a vision of both stories making sense synchronously. There's no contradiction or limitation; comprehension arrives in a kōan-like manner. During my "ten year challenge," in the trading industry, I've seen common misconceptions exploited in the service of sales mojo. Reflecting on my decade of experience, I’d like to explore those myths and legends and reveal how they affect the trader's ability to succeed.
A Books, B Books, and Hybrids
When it comes to Forex trading, three systems determine how a client interacts with their broker: A Book, B Book, and the hybrid model. While A Book trades favor the client, B Book, or “dealing desk” trades are more beneficial for the brokerage. In a hybrid model, the clients fall into A Book or B Book based on their profitability.
So what’s the difference and what should you keep an eye on? In A Book trading, used by ECN/STP brokers, intermediaries are used to send client trading orders to liquidity providers or multilateral trading facilities (MTFs). This trading puts the client at the forefront and eliminates the conflict of interest that can exist when brokers trade against their clients. In this scenario, brokers make money by charging commissions on volume orders or increasing the spread. Because the broker makes money on both winning and losing trades, there is no incentive to bet against the client.
For Forex brokers using B Book, client orders are collected internally and the broker profits when the client fails. Brokers manage risk through internal hedging, spread variations, and by matching opposite orders. Because so many traders lose money in Forex, B Book can be very profitable for brokerages. Unfortunately, the profit comes at a price - the disadvantage (and loss of funds) of the client.
In a hybrid model, brokerages use software to identify successful and unsuccessful clients by analyzing their orders. By filtering traders based on the deposit amount, leverage, risk, and other elements, brokers can divide their clients into two groups: winners and losers. The winners get A Book treatment, and the losers must settle for B Book.
As you can imagine, A Book is becoming the popular choice for Forex traders because they aren’t at odds with their broker. Removing the incentive to bet against the client and focus on the trades activity to create profit creates a more amicable environment and helps forge a stronger relationship between the trader and their broker. Additionally, profitable trades actually increase trading volumes and positively impact the broker’s profits, which encourages brokers to help their clients succeed.
A/B-book vs. ECN Makes a Difference
Let’s start on the tech side. Whether your brokerage uses an A-book, B-book or ECN to execute trades is irrelevant to your performance. When choosing a brokerage, you want an organization authorized and regulated in a domain where the law is on your side. Why is that important? Because you want the ability and legal means to withdraw your profits without difficulty.
So what differentiates A/B book from ECN?
For starters, when you lose money on a B-book trade, it stays with the broker. Losses from A-Book or ECN stay with brokerage’s liquidity provider. Guess what happens when you earn more on B-book than your broker can provide? Well, in the latter case, it’s their own problem as long as you’re covered with a legit local Financial Supervisory Authority.
Another differentiator? Technically, B-book trades can sometimes execute faster because no market confirmation is needed. Of course, that depends on a fair B-book. It could be argued that the difference between A-book and B-book is illusory. For example, T4 plugins or custom bridges can use hooks to delay when an A-Book trade is communicated to the liquidity provider. It should be noted, however, that the idea of pure A-books and B-books are marketing rudiments of the past. Trades can be delayed automatically or by dealers before ever being communicated to the liquidity provider.
The illusion of faster trades is significant. If you are seeking an ECN with an advanced HFT algorithm that supposedly beats the market, for example, you might fall for a pitch that doesn't deliver. Be vigilant when vetting brokerages. Keep in mind that some players try to trick the game with the existence of algorithms on the liquidity provider’s infrastructure. They do this by exploiting infamous arbitrage and ultra-high frequency tactics. Remember, they’ve been there for ages. Even if you plan executes, keep in mind the compliance department can block your withdrawals for any length of time based on any legal reason.
This one platform is better than the others
In an ideal world, we assume brokers use certified technology and can’t distort the market data or mess with your actions. Unfortunately, that's not always the case. At present, no relevant regulations exist and, in most cases, nothing can be proven. In fact, the only reason the majority of brokerages does not do it is that 99% of traders lose their money themselves, sooner or later, legally.
Some uninformed brokers on the market do distort data or manipulate results. Fortunately, they quickly end up in the Forex Peace Army blacklist and fade away. Well, they don’t really fade away. They continue to show up periodically. Often with rebranded names, like Phoenix. You can spot them by the platform (usually not changed) and a dodgy registration location, like Vanuatu. If you're curious, just Google the address of registration. If you see a dozen other companies registered for that same address, you know what type of beast you are dealing with.