UNIT A| Absolute Essentials

4. True And False Myths

Some traders do not feel comfortable with their broker being on the other side of their trades as they feel it presents a kind of conflict of interest. This is a worthwhile concern, certainly, but the fact of the matter is that the majority of Forex brokers are forced by competition to remain honest. There is no way for a broker to survive in the business unless the company keeps up its end of the deal.

As you already know, most countries have their own body or association that serves to regulate the sector in that country and ensure that clients' rights are protected. This body will insist on its members accepting the decisions of their arbitration panel in case of disputes. This should address the question about the safety of the funds and the lack of overall regulation. There is a lot being done recently in this regard and expect new regulations to come which will provide traders with more protection.

There is another common tendency amongst some retail currency traders to claim that Forex brokers trade against you and their main agenda is to wipe out your account hunting for stops. For an aspiring trader this information is very discouraging.

What happens is that, precisely because of the high leverage effect, most retail traders are forced to trade with stop losses. Otherwise, there is a risk of a forced liquidation in the form of a margin call.
As most of the stop orders are programed on the platform, the broker's dealing desk has access to this information. Not that the broker is watching your particular position, but rather the entire positions of the entire client base. This includes seeing where the most stop orders are clustered.

It's true that Forex broker-dealers, as market makers, can expand the spreads at any time. But more than often that is not what happens. You see, the information about price levels where stop orders are clustered is passed into the interbank market in the case of a non-dealing-desk broker. And the fact is that the market will react to those orders. In the Forex market stop losses are interpreted as orders, that is as a willingness from market participants to take action at a certain price level. A stop order always corresponds to a sell or buy order, and the market will react to it. This subject will result clearer to you studying the next chapters, as more pieces of the puzzle will be revealed.

 

Boris Schlossberg, although in the context of disclosing a trading strategy based on stop order executions, explains the process in his article "Stop Hunting With The Big Players":

It should not be considered stop hunting when the price simply goes against you by 30 or 40 pips all the way to hit your stop order. To move the price by so many pips, the broker would have to accumulate a position of millions of Dollars in the process. Besides, their agenda is to get you to trade more and therefore earn more via spreads, commissions, rollovers, etc. If you wipe out your account they probably loose a costumer.

Richard Olsen explains why the Forex market over-shoots all the time in its pricing:

The hole in the story is that an artificial movement of the exchange rate represents a huge risk for the broker as well, as this position may have to be compensated in the real market. A different situation is, like Boris Schlossberg points out, that strong market players, like banks or hedge funds, coordinate their actions around key price levels. In such a case, a cascade of stop orders can eventually accelerate momentum and change the direction of a trend.

The question is: is such a myth really unbiased or is it written by traders who emptied their accounts because of lack of experience? After all, we only tend to complain when things go bad!

There is also the myth that a broker without dealing desk or an ECN broker is more likely to be honest about the trades since it passes your trading orders off to the interbank.

John Jaggerson and Wade Hansen explain why NDD brokers and ECNs are not necessarily better then market makers:

A dealing desk is the place at an institution where contracts are bought and sold. Your dealer may imply that by trading with them you will not have to work through a dealing desk, giving you better pricing. This is not true. It may be correct that your order won't be handled by your dealer's own dealing desk, but your order will eventually wind up on someone's dealing desk at one of your dealer's broker banks. If it is going to cost you the same amount of money in the end, does it matter to you whether your order is handled on your dealer's own dealing desk or Goldman Sachs' dealing desk? The dealer you work through and your dealer's broker banks will be compensated for the service they offer, and it will be a cost to you.

And they go on writing:

To every dark side, there is a plus. In the case of retail brokers, they provide an advantage: you can open an account with very little investment and get very high leverage. With an ECN Forex broker the leverage is generally much lower and the minimum account deposits are higher.

These are some criteria that you can follow on your due diligence and that will protect you from the rare but possible event you experience major problems with a broker-dealer. Another measure you can adopt is to split your funds among few brokers. Sometimes even apparently good companies go bankrupt and it can catch you unprepared. Besides, by working with more than one broker, you can profit from more features and get to know which of them make you feel comfortable.