Discussion in 'Forex Brokers' started by TradeViper, Aug 30, 2006.

  1. My purpose in starting this thread is to pull back the FOREX curtain just a bit, so we can take a good look at the "wizard".

    First of all we need to understand what we are talking about when we say ECN.

    The first thought that comes to mind are the ECN's that enable trading on the NASDAQ market. These ECN's, do nothing but communicate Bids, Offers, Last, Size, depth of market and orders. Hence the acronym, ECN, Electronic COMMUNICATIONS Network

    Here are some points to remember about true ECNs and the market places they work in.

    1. The ECN has nothing to do with setting the prices

    2. The ECN communicates with a central market place

    3. The central market place (nasdaq) pushes the quote data of the price action on the different ECN's, which includes depth of market and Id of participant if shown, to the broker, the broker then passes it on to the trader.

    Now here are the differences

    1. Forex does not have a central market place

    2. The ECN programming does mess with the prices

    3. There is a limited circle of liquidity

    Lets use an example, I bid 50 qqqq at a specific price. My order waits in line until it is filled. Now here is the biggest difference between Forex and Nasdaq, this bid is being offered to the whole universe of Q traders, not just a select pool of liquidity, or two or three liquidity providers. So no matter where you live or who your broker is, if the feed comes from the Nasdq, everybody sees the bid, 50 shares qqqq at x, minus any latency from the broker.

    Knowing this we can compare our example to the CurreneX (CX). CX in its purest form is a true ECN. But since there is no central market, the brokers control the liquidity. Remember also that CX is fully customizable by the broker. This means that the scope of liquidity seen by the trader is limited by the white label broker. The CX allows for "hubs" of liquidity, or groups of liquidity providers.

    For example, if your broker has a relationship with 5 banks, and 5 large hedge funds/brokers, plus any "local liquidity" or retail traders, this is what you will see on your quote feed.

    But we are only talking about quote feeds above, the broker can also restrict who you execute against. So out of 11 feed providers you may only be executing against 1 hedge/broker and the locals, and not the banks. And really, if you are not executing size, you are not going to interact with the banks.

    Of course if you need more liquidity the broker will only open it up to you if you are trading larger size. The reason for this is $$$$$. To get to these feeds the broker has to pay, so to make up for this, you, trader dude or dudette, need to trade size so that they can be compensated for the fees they pay. Remember the larger the size the greater the fees. (egad, did I just say that!!!)

    Now Hotspot is another true ECN, but they do not use liquidity pools, what you see is what you get. But remember, you only see the quotes and liquidity that Hotspot provides through the banks etc. that they have relationships with. They do not have all of the banks in the world trading on their platform.

    Why is this the case, again, no central market.

    Now there are other platforms that claim to be ECNs, and compared to passing orders through a trading desk I guess in a sort of a Forex kind of way they are.

    But the programming of the platform changes the spreads with some platforms. For example one broker clearly states that during time of high volatility the spreads will widen. Ok, we know this going in, but where does this widening of the spread come from. It DOES NOT come from the banks, if you have a pure feed from Hots or CX, you will see that the spreads in general, do not widen right before news. The spreads will bounce like crazy for a few seconds, but this is normal price action. Any platform that has a fixed wide spread before news is doing so artificially.

    Why do they do this? How the heck should I know. Some say it is to prevent incurring losses, and other reasons. But I will tell you it is not the banks who do this.

    Now what does this mean to retail traders, not much. For example my 50 shares of qqqq will probably be filled by some other wiener like me who is trading 50 shares, and not by CANT or NITE. So even if your Forex trades are executed against other traders and not by the banks, if you are profitable who cares.

    Again, there is no guarantee on the Nasdaq that you will execute against NITE or CANT if you are not trading size, but you are literally participating in the whole market and not just a segment.

    The problem is that some brokers like to represent themselves in a way that is, well not exact. An ecn on the Forex works wayyyy different than an ecn on the Nasdaq. To some it may be a case of "define ECN'" and semantics. But you have to know that when somebody sees the acronym ECN used they think of the Nasdaq model. This is not the case in FX

    Anyway, the answers to all of your questions is 42, yes, I have thought it over quite thoroughly and the answer is definetly 42.

    The Ever Hitchhiking VIPER
  2. Glenbuck


    Nice summary there TV.

    What I'd be interested in, is whether liquidity providers like banks provide single tranches of liquidity across the various ECN platforms and as soon as its been taken, say on Currenex, pull that liquidity from Hotspot, Lava, Espeed, etc.

    If not, then someone could pool the liquidity from all the fx ECNs out there and then in theory have $100m's either side of a pip on EURUSD available to trade.
  3. The structre of fx brokers (Interbank and ECN) – a short essay

    excerpt from:

    An ECN operates similar to a Tier 2 bank, but still exists on the third tier. An ECN will generally establish agreements with several tier 2 banks for liquidity. However instead of matching orders internally, it will just pass through the quotes from the banks, as is, to be traded on. It’s sort of an EBS for little guys. There are many advantages to the model, but it is still not the Interbank. The banks are going to make their spread or their not go to waste their time. Depending on the bank this will take the form of price shading or widened spreads depending on market conditions. The ECN, for its trouble, collects a commission on each transaction.

    Aside from the commission factor, there are some other disadvantages a speculator should consider before making the leap to an ECN. Most offer much lower leverage and only allow full lot transactions. During certain market conditions, the banks may also pull their liquidity leaving traders without an opportunity to enter or exit positions at their desired price.

    Trade Mechanics:

    It is convenient to believe that in a $2tril per day market there is always enough liquidity to do what needs to be done. Unfortunately belief does not negate the reality that for every buyer there MUST be a seller or no transaction can occur. When an order is too large to transact at the current price, the price moves to the point where open interest is abundant enough to cover it. Every time you see price move a single pip, it means that an order was executed that consumed (or otherwise removed) the open interest at the current price. There is no other way that prices can move.

    As we covered earlier, each bank lists on EBS how much and at what price they are willing to transact a currency. It is important to note that no Interbank participant is under any obligation to make a transaction if they do not feel it is in their best interest. There are no “market makers” on the Interbank; only speculators and hedgers.

    Looking at an ECN platform or Level II data on the stock market, one can get a feel for what the orders on EBS look like. The following is a sample representation (see screenshot posted below):

    You’ll notice that there is open interest (Level II Vol figures) of various sizes at different price points. Each one of those units represents existing limit orders and in this example, each unit is $1mil in currency.

    Using this information, if a market sell order was placed for 38.4mil, the spread would instantly widen from 2.5 pips to 4.5 pips because there would no longer be any orders between 1.56300 and 1.56345. No broker, market maker, bank, or thief in the night widened the spread; it was the natural byproduct of the order that was placed. If no additional orders entered the market, the spread would remain this large forever. Fortunately, someone somewhere will deem a price point between those 2 figures an appropriate opportunity to do something and place an order. That order will either consume more interest or add to it, depending whether it is a market or limit order respectively.

    What would have happened if someone placed a market sell order for 2mil just 1 millisecond after that 38.4 mil order hit? They would have been filled at 1.5630 Why were they “slipped”? Because there was no one to take the other side of the transaction at 1.56320 any longer. Again, nobody was out screwing the trader; it was the natural byproduct of the order flow.

    A more interesting question is, what would happen if all the listed orders where suddenly canceled? The spread would widen to a point at which there were existing bids and offers. That may be 5,7,9, or even 100 pips; it is going to widen to whatever the difference between a bid and an offer are. Notice that nobody came in and “set” the spread, they just refused to transact at anything between it.

    Nothing can be done to force orders into existence that don’t exist. Regardless what market is being examined or what broker is facilitating transactions, it is impossible to avoid spreads and slippage. They are a fact of life in the realm of trading.

    Implications for speculators:

    Trading has been characterized as a zero sum game, and rightly so. If trader A sells a security to trader B and the price goes up, trader A lost money that they otherwise could have made. If it goes down, Trader A made money from trader B’s mistake. Even in a huge market like the Forex, each transaction must have a buyer and a seller to make a trade and one of them is going to lose. In the general realm of trading, this is materially irrelevant to each participant. But there are certain situations where it becomes of significant importance. One of those situations is a news event.

    Much has been made of late about how it is immoral, illegal, or downright evil for a broker, bank, or other liquidity provider to withdraw their order (increasing the spread) and slip orders (as though it was a conscious decision on their part to do so) more then normal during these events. These things occur for very specific reasons which have nothing to do with screwing anyone. Let us examine why:

    Leading up to an economic report for example, certain traders will enter into positions expecting the news to go a certain way. As the event becomes immanent, the banks on the Interbank will remove their speculative orders for fear of taking unnecessary losses. Technical traders will pull their orders as well since it is common practice for them to avoid the news. Hedge funds and other macro traders are either already positioned or waiting until after the news hits to make decisions dependent on the result.

    Knowing what we now know, where is the liquidity necessary to maintain a tight spread coming from?

    Moving down the food chain to Tier 2; a bank will only provide liquidity to an ECN or retail broker if they can instantly hedge (plus their requisite spread) the positions on Interbank. If the Interbank spreads are widening due to lower liquidity, the bank is going to have to widen the spreads on the downstream players as well.

    At tier 3 the ECN’s are simply passing the banks offers on, so spreads widen up to their customers. The retailers that guarantee spreads of 2 to 5 pips have just opened a gaping hole in their risk profile since they can no longer hedge their net exposure (ever wonder why they always seem to shut down or requote until its over?). The variable spread retailers in turn open up their spreads to match what is happening at the bank or they run into the same problems fixed spreads broker are dealing with.

    Now think about this situation for a second. What is going to happen when a number misses expectations? How many traders going into the event with positions chose wrong and need to get out ASAP? How many hedge funds are going to instantly drop their macro orders? How many retail traders’ straddle orders just executed? How many of them were waiting to hear a miss and executed market orders?

    With the technical traders on the sidelines, who is going to be stupid enough to take the other side of all these orders?

    The answer is no one. Between 1 and 5 seconds after the news hits it is a purely a 1 way market. That big long pin bar that occurs is a grand total of 2 prices; the one before the news hit and the one after. The 10, 20, or 30 pips between them is called a gap.
  4. screenshot
  5. Thank you TradeViper and NZDSPeCIALISt. You guys have spent a lot of time with your posts and I have learned from them. They are actually printable.

    Forex traders, you will finally get to the bottom of the mechanics of the Forex market, both secondary and primary, by reading and perusing the posts in ET.

    How can we understand the mechanics of what we trade when it has been secret so long?...or maybe its just me and I haven't had a clue for too long.

    Michael B.
  6. I dont agree with ECNs being EBS for the little guy, there is a huge difference between EBS and the likes of Currenex and Hotspot.

    EBS is still mainly a manual execution venue for banks, most of the time a bid or offer is only placed into the system when there is interest, this is changing with apis. Secondly credit is restrictive, you can only deal with banks that you have a direct relationship with so if your line is full you will not be able to hit those prices. It is not readily open to the market.

    At the price Currenex and Hotspot have more available liquidity, i.e they may have average of 10 15 available where EBS only has 2-5 (eur/usd).....

    both of these ECNS also have streaming prices from banks and hedge funds, and this is where they better EBS, clients have become liquidity providers. They are taking over the role of banks to provide liquidity into a market place. This is where Nz is bang on..and where a little understanding needs to be had...the higher price for dealing on these platforms is down to the clearance of credit necessity but also the constant prices they will see...during times of market fluctuations (non farm payroll this week is an example0 liquidity will dissappear...As I said on another post to Viper, dont complain about the spread because banks have no more idea than you do when making a price during these moves, Streaming prices are based aroudn EBS and Retuers and they have no liquidity during these moves either...they will either widen or pull ... if you want to deal then a client has the ability to make a price to the market.

    The holy grail of course is providing a centralised credit mechanism and currently they have been much more successful in this with prime brokers than EBS. Its not centralised in the true sense and indeed as Viper correctly noted Currenex has hubs so if you get the wrong pb you could get really bad liquidity ...(confuses me why the wouldnt put everyone into a centralised pool ?) and of course Hotspot as viper correclty noted is a centralised market place in the sense everyone sees the same price.

    As for price movement and spread there is more available liquidity in the market place now than there has ever been, the main difference is how many traders have access to that information and can trade on it.

    Spreads have narrowed to reflect this, to a point where retail trading has exploded over the last 5 years, however this has led to unrealistic fight over spread. Where a 2nd or 3rd teir broker relies heavily on bank streams to cover their business, there is a huge risk that those banks pull their liquidity if they themselves do not make enough on the volume...this is why its important to consider a longer term solution where clients can deal with clients

    actually im bored and rambling now......

  7. Viper says the banks don't widen the spreads but that's something that happens on retail platforms, or in other words the banks continue to quote the market. NZDSpecialist says as the news event becomes imminent, "banks on the Interbank will remove their speculative orders for fear of taking unnecessary losses."

    I have been watching Idealpro and MB Trader and while spreads do widen out a bit on the immediate jolt of the news, there seems to be a constant quoting, and after several seconds, the spread comes back to 1-2 for EUR/USD and seems to be tradeable. Is this a case where some of the banks who quote would renig on their quote?
  8. I'd like everyone to think about a different kind of story to point out how ridiculous it is that banks can get away with not honoring quotes. Let's say Joe Trader, trading one lots from his basement office like he's on a mission, gets filled on one of his offers during "high volatility" of a major news event. Joe isn't happy with what has happened, so he goes direct to the source. He phones UBS, who lifted his offer and tells the head trader on the desk that "I'm busting my trade with you UBS, because you hit a stale offer I had in the market, because my auto quoting program was busy going to the bathroom when the news hit." One can only imagine the laughter Joe would hear on the other end of the phone.

    Folks, if Joe Trader has to honor his offers, how do banks get away with not honoring theirs? Seriously, there is something fundamentally wrong with that concept. If banks suddenly were no longer "the game" but were merely a participant in "the game" this would all change. But I just don't see that happening anytime soon. One of the only fx marketplaces that doesn't seem to allow banks to weasel out is in FX futures on the CME. Interactive Brokers' IdealPro lets them weasel out. What about MB Trader or Hotspot? It sounds like Currenex lets banks weasel out.
  9. Hi,
    I have been checking out Hotspot (retail) and i like it so far. The only minor gripe that i have is, that you arent allowed to change orders if the price is within X pips. I have been told that is a common practice on more professional multibank plattforms. Is that true, and if yes, whats the reasoning behind that?
  10. Let me explain about the widening spreads. My criticism is with the platforms that artificially widen the spread before news. I have heard that, before news on some platforms, the spread is a constant 10-20 pips. This does not happen on CurreneX and Hotspot.

    That is what I mean by the banks not widening the spread. The banks can and will pull quotes, so the widening of the spread is a reflection of these pulled quotes. And it is not constant, it bounces all over the place. This kind of action is impossible to execute against in a logically planned trade.

    Sure you want to throw a market at it, you will get filled, and then you will get crushed :cool:

    The Ever Clarifying VIPER
    #10     Aug 31, 2006