Dark underworld of forex trading: "A-books" and "B-books"

[OddTrader]

The dark underworld of forex trading

http://www.theage.com.au/business/markets/the-dark-underworld-of-forex-trading-20150121-12uoi9.html

" ...

The industry's dirtiest little secret is the extent of trading profits that brokers earn by directly taking on their muggiest punters.

While some platforms act like true brokers others are more akin to bookmakers. They're understood to split their trades into what is known in the industry as "A-books" and "B-books".

The "A-book" describe the trades the broker receives that are passed on to the inter-bank market with the broker clipping a ticket.

The alternative "B-book" consists of trades that the broker has not passed on to the market but taken on themselves.

Why would brokers take on their clients? Because an estimated 95 per cent of retail traders are pre-programmed to fail, which means the brokers will ultimately win by taking them on rather than passing them off to the market.

The existence of leverage amps up the movements in clients' positions, making it more likely that a stop-loss (mandatory sell order) will be triggered, speeding up the inevitable loss. And with brokers trading against their clients, they may possess the ability to tilt the game in their favour.

This includes inserting charges such as "cost of carry" that retail punters have little chance of reconciling. It has also been suggested the brokers can and do widen their bid-to-offer spreads momentarily to hit the stop-losses, forcing a loss on the client.

The B-book does carry risks that a large savvy trader will bet big and win, which means the larger accounts are shifted to the A-book where the broker pays an inter-bank dealer a fee.

"B-booking" is a taboo subject and brokers are loath to admit they engage in betting against their clients. But insiders are convinced it is an integral part of several of the brokers' business models that required them to constantly market for new clients.
Cottage industry of trading analytic firms

As evidence of B-booking's prevalence, a cottage industry of trading analytics firms has sprouted up to help brokers identify which clients have even the faintest idea what they're doing. They're then shifted to the A-book.
...
"

 

[i960]

And now come the "journalists" following the trail of blood. Why do they never write these "exposes" on their own time without a precipitating event? Oh that's right, eyeballs and $$$.

Also, leverage == more likelyhood stop loss will be hit? Such crap sensationalism.

I agree with the sentiment - it's the timing of the reporting that I take issue with. Opportunistic.

 

[southall]

Nothing new, they are called bucket shops, and have been around since the 1800s. Livermore days.

Difference is fast and low cost electronic trading allows them to hedge winning punters these days. But why bother to hedge losing punters? Doesnt make business sense.

But even today when they find they cant hedge cheaply or its almost impossible (eg binary options) they will requote you or limit your trading size.

 

[ronblack]

Also, leverage == more likelyhood stop loss will be hit? Such crap sensationalism.

It spells "likelihood"...well, I also make mistakes when the speller is turned off.

Why not? Many use a dollar stop and not everyone uses a price for a stop. The problem is worse than described because high leverage leads to ruin of accounts for most retail customers. I'm not talking about the pros. High leverage may be soon limited through legislation. Here is an article on this.

 

[i960]

My point is that leverage has no relationship to a stop loss being hit, price does. The way it was worded implied that using high leverage means the trade is suddenly more apt to hit a stop loss - which is basically only true in a fairly indirect manner.

As far as regulations go, we'll probably not even be talking about this in a month. You know how it goes. I don't agree with 10x either. 100x is ridiculous though.

 

[CliffordHarris]

OddTrader is exactly right. The A/B book issue is real. Think about it, if you have the other side of the trade you want your client to lose. You want them to blow a hole in their face, why, so you keep their money. That is the game. They lose you win. So if you give someone a slingshot they are not likely to kill themselves with it. But if you give someone a semi-automatic weapon they can blow up real quick.

Do you think the retail forex firms are giving leverage because they want to help the retail trader? No. The more leverage you give the greater the likelihood the traders uses it and blows up. They blow up you make all the money they deposited. Nice gig if you can get it.

Like it or not, with the blow of FXCM retail forex is over. How many lobbyist do you think the CME has dedicated to this issue? This is the chance for the CME to bury retail forex once and for all.

 

[CliffordHarris]

FXCM's debit was the beginning of the end - http://www.cftc.gov/PressRoom/SpeechesTestimony/bowenstatement012115

 

[VPhantom]

As evidence of B-booking's prevalence, a cottage industry of trading analytics firms has sprouted up to help brokers identify which clients have even the faintest idea what they're doing. They're then shifted to the A-book."

Fascinating! I always wondered how much of their clientèle the market maker shops actually hedged in underlying markets. A quick Google search reveals Currenex and R3 Analytics as two big such firms. Neither of them appears to be "shady" about the fact that they help sort retail traders this way, with Currenex writing of "synchronous (A-Book) and asynchronous (B-Book) hedging" and R3 Analytics calling them "B-Book Skill Aversion and Risk Optimisation strategies".

Personally, if we set aside stop hunting I don't mind this bucket shop strategy at all. Especially if it means getting perks like having our losses limited to the funds deposited as we saw with Oanda, Dukascopy, FxPro and possibly FXCM (and I think Gain?) with the CHF last week. So what, if less liquidity is relayed onto the underlying exchange, if it means as a small-game retail trader that I'm less vulnerable to a force majeure? It wouldn't be possible if the bucket shop wasn't making a boatload of money on its majority of losing traders. I'm thinking twice about trying futures with my modest account at a "normal" brokerage after hearing CHF horror stories, seeing the friendly loss limits in place at CFD shops...

Now, stop hunting is a show stopper however. I had an account at a lesser CFD shop some years ago and could never keep my stops loose enough to avoid weird ticks just deep enough to kick me out; ticks not visible on, say, eSignal for the same instrument. (And no, "mental stops" aren't for me: I want to be protected against technical outages at all times, so I always use brackets.) I wonder how often stop hunting still happens at the bigger shops; maybe their earnings against losing clients are enough that they don't go this far anymore? Wishful thinking!

 

[doggyfx]

What about so called "trade receipts" with details of execution? Would they serve for a solid proof that broker doesn't involve itself into tricky schemes? Could I request receipts on particular "dumb" trades from my broker to check is there any LP prints on them?

I really want to give a test to my broker as I believe knowing exact execution models will help to adjust my trading and get better execution as ultimate goal.

 

[VPhantom]

What about so called "trade receipts" with details of execution?

I don't know about those. Forex and CFD market makers don't have to show us proof of anything more than what transpired directly in our account, no counterparty or exchange disclosure.

I really want to give a test to my broker as I believe knowing exact execution models will help to adjust my trading and get better execution as ultimate goal.

Now that's interesting. On one hand, you're likely to get faster entry stop/market executions, with less or no slippage if the market maker's taking you on, but on the other hand it pretty much forces you not to use stop-loss orders to avoid suspicious price movement if you're just on their books. Not only that, but by trying to take advantage of being on their B-Book, you'd probably trigger a move onto their A-Book and lose your edge. Come to think of it, this boils down to trying to game their analytics firm's hedging algorithm as much as the market... And this assumes that one trader is always either on the A or B book; for all we know they may hedge each trader dynamically based on lots of factors like time of day, day of week, instrument class, etc. They might be better at deciphering our patterns of success and failures than we are! :eek:

I thought about doing exactly that with my former CFD bucket shop, but finally just gave up and eventually moved on to "big boy" brokerage. (I'm at I.B. now though contemplating using someone like Oanda as a backup, with the bonus that apparently you can't lose more than your deposit there, useful for a small high-risk account.) I figured that if the rules are opaque and thus likely to change at any time, then finding an edge against the market maker is probably pointless or at best short-lived, and I'd rather learn an edge directly applicable to the market than to a specific counterparty.