just trying to figure where my pay comes from. lets say for example (hypothetically) i trade on IB's Ideal Pro FX, and im trading against the UBS desk (the guys who participate in IB's ECN forex market), they make the spread and probably hedge in the cash market and they have a air tight arbitrage model. say for example im the only trader, trading there spread and after a year i have made 1,000 pips, where does that come from cause surely they wouldnt be losing money?
Lets make a simple model: you trade against a market maker who makes two sided markets against the "cash" market based on one end user customer of the market makers bank (this could be say a big industrial company like say GM) The prices they quote to you is based on the order flow they /know that the customer is giving them in the cash market. So you buy from their offer, they get to buy on their bid against the customer locking in a profit. The thing goes up and the process is reversed. You made money, the market maker has made money and the customer has paid you both. However the customer has not lost, they were just hedging their cash flows over seas. So ultimately its the guy on the street buying a car that pays. Now in the real world this is not as simple, the market maker probably does not know what his order flow is on the other side, but he can make an educated guess. Furthermore, he does many trades at the same time in many pairs/instruments so there are likely never a clear cut arbitrage, just edges.
dantes, thankyou that makes sense, but does that theory apply to market markers in the EURO on GLOBEX, are they accepting orders in the cash market to capture the spread or are they only showing size on the bid/offer if there is a arb opportunity, and does that mean any money i make on GLOBEX is from weaker players?
On a market like the Globex there are many different players and to make a complete model that incorporates them all would be very complicated. Some examples of players on Globex would be: 1. Banks that make markets in cash 2. Speculators (I would guess this is your kind) 3. People who make arbitrages in other instruments that involve currency risk (such as arbitrage in stocks listed in multiple currencies) and use Globex to hedge that exposure 4. Savy industrial companies that hedge their currency exposure direct in futures etc... So in general I would say there is no good easy answer, although your questions is very interesting and could be made the subject for a Phd thesis
thanks dantes that helped clear up my mind. i now think that my pay comes from paper that is not to fussed about every tick and pip whereas i am.
you're missing out spreaders on globex - those who buy the front month and sell the next month - to profit from differences in contract prices and the spread.