Slippage is normal. Price variation is normal. What is not normal is cancelation of profits, or preferential behavior by b-book brokerages under strange and non-existent terminology such as off-market pricing. We investigate in full and show how this works, with full insight from within the bank, non-bank and brokerage sector
This is a matter that has been raised since the dawn of retail FX trading and one could almost regard it as one of the top two reasons that a broker may decide not to pay a trader’s profits when a withdrawal is requested.
“You traded on off market pricing” and a reference to a clause in a broker’s terms and conditions seemingly allowing a broker to cancel your trades may appear incorrect practice at first glance, therefore we take a look at what off market pricing is and when is your broker playing fair or not.
Who’s pricing the market?
There is currently a degree of ambiguity which a retail trader faces when selecting a brokerage, largely due to the similarity of many end-user platforms and the inability for retail traders to see the mechanisms connected to them.
We have to look at how prices are generated from market through to your trading platform’s price feed in order to gain some much needed perspective required to put our unbiased hats on.
It’s not that complicated but will form the base of this discussion. We asked a senior prime of prime brokerage executive with almost 40 years of experience in the interbank and institutional currency trading industry for insights and clarity on how currencies are priced, how a traditional hierarchy would look like and how orders are processed.
Each tradable instrument has a market price that consists of a buy and a sell price. Without going into detail of how this price is generated or affected at a market level, we start at the point where the market has a price generated.
This price differs and is constantly changing. Whilst there is no physical exchange per say, liquidity pools and banks are providing pricing on currencies.
These prices are affected by many different factors such as:
- Banks / liquidity pools / traders willingness to execute at a price
- Time of day, location in relation to the instrument
- Sentiment, news, fundamentals
- And a whole lot more… let’s dissect in greater detail.
At the raw pricing level, the interbank market generates pricing and this fizzles down through the different tiers (explanation a little further down).
Tiers tiers and more tiers
Now that we have a price, we can go deeper through the tiers until you as a retail investor are able to click buy / sell on your trading platform of choice.
The first level in most of the cases will be your Prime of Prime broker who has access to the interbank liquidity and ability to pass orders through. By the time it gets to the Prime of Prime level a fee is added as you have a set of “hands” on the price.
The add on fees per million or commissions charges pays for their costs to operate and in turn to make the business profitable as is with any business or service provider.
Prime of Prime is a term most experience retail traders are familiar with, however; retail traders are not yet able to execute at this level and we have to go a tier down. We explain exactly what constitutes prime of prime relationships here.
Prime of Prime brokers sell on this liquidity / pricing through to the next tier and so happens to be called Tier one brokerages. The prime of prime broker is providing a wholesale service. At the tier one level a retail trader has the ability to execute orders.
There are many tier one brokers in the market offering retail trading and most are well capitalized, have history and good standing in order to secure this prime of prime relationship and solidify themselves at the tier one level.
In essence, by the time you as a retail trader are trading directly with a tier one broker, you have at least seen two “hands” on the price that you will be able to trade on, the brokers (tier one) and the prime of prime.
Just to clarify, there are many factors that would determine what a good price this far down the spectrum would be on say; EURUSD, however; seeing a 0.2-.03 raw unadulterated spread (per million) at this level is very normal.
Add the retail broker’s fees (commissions / fees / spreads / bridging costs) and you have a price to trade on.
Whilst there are cases where a spread can hit choice (zero), this is very very rare this far down the chain due to the amount of “hands” that have added to the price this far down.
Most brokerages will add the additional costs to the total cost of trading whether it be part of the spread, or a commission on top of a raw spread based on:
- Bridging fees (depends on the platform provider, prime of prime etc)
- Liquidity provider charges (per million)
- Platform charges
- Broker’s costs to keep the business open
- Normal variation in raw spread affected by above mentioned factors
So now we have a tradeable spread. A buy / sell (bid / ask) price that you can as a retail investors click away and trade on.
In some cases, however, there are brokers out there that are tier two brokerages. What this means is that they are getting their liquidity from a tier one brokerage. Again, adding the additional tier leads to an increase in the price.
Often, as usually is the case with tier two brokerages is that they are White Labels, smaller brokerages, or those just starting out that are not well capitalized enough to go direct to the prime of prime.
Moreover, most prime of prime brokerages will not accept unregulated brokerages or those without history due to the liquidity and counter party risks involved with providing liquidity.
As is known, and obvious considering how competitive the market place is, a tier two brokerage often works on a revenue sharing model with the tier one broker. This keeps the spreads / commissions fair or at least on par with their tier one competitors (same retail customers) and often risk is passed onto the tier one broker with profits being shared.
Then, even with a very transparent prime of prime brokerage agreement in place, the eFX execution desks at the Tier 1 banks have a substantial upper hand.
Cost, a constant nagging possibility that a counterparty credit agreement could be terminated, and the last look practice which is instrumental to many single dealer platforms are factors that are unpleasant realities within the dealing desks and trade processing divisions of most brokerages, however it is widely tolerated because Tier 1 bank liquidity is the top of the market.
With the banks coming back into the fray, market makers which have likely been very quietly mopping up some of the business that the banks have rejected, are now having to once again demonstrate their competitive edge.
In May this year, XTX Markets removed its discretionary latency buffers in the last look window when trading with direct counterparties on a disclosed basis, using the terminology “Zero Hold Times” or ZHT in the world of three letter acronyms in which we have so long operated.
XTX Markets, along with Citadel Securities, are two of the most prominently used non bank liquidity providers, have been building up their base of prime of prime brokerages with whom to use as a distribution channel for their liquidity to retail brokerages which are in turn clients of the prime of prime brokerages, and now operate with the vast majority of companies worldwide.
At a time during which the banks are beginning to realize that the complete curtailment of counterparty credit to FX firms is absolutely counter to their core business activity and is a revenue stream that they cannot afford to ignore, last look has begun to come out of its stalemate situation and is now under the microscope, not only of the regulators, but of a far more aggressive force, that being the litigation suits brought by brokerages.
Unfortunately, whilst Alpari US’s efforts were noble, it is very unlikely that a retail firm of that size would be able to set a precedent by taking the banks to task for last look practices, hence the legal giants will work tirelessly to prevent these cases getting any traction.
It is also something of a byproduct of the trust-based OTC relationship between bank, provider, broker and trader that creates an unwillingness among Tier 1 bank FX desks to discuss this openly.
Some regulatory authorities, including the European Securities and Markets Authority which is responsible for the implementation of MiFID II which instructs a specific infrastructure-led route to transparency, consider that they wish to put as many items that can be cleared on exchanges onto listed derivatives venues, however FinanceFeeds considers that this will not remove any conflicts between components of the trade execution process as it will place broker and trader on the same level.
Indeed, this may make it easier to access pricing, as all transactions will be made public information and conducted by an impartial exchange, but that does not mean that a brokerage cannot be a market maker on the exchange, remove its liquidity relationships and use the exchange, perfectly legitimately, to trade against its client – exactly the process that the MiFID II rulings is attempting to extinguish.
From the non-bank ECN perspective, a senior executive within a large American non-bank institutional FX company recently explained his perspective to FinanceFeeds.
“In statistical and absolute dollar PnL terms, 100-300ms last look does very little on benign order flow when makers have good pricing systems and attempt to fill all profitable orders. Most of the venues cap last-look at 100-200ms and require fairly high average fill rates for market-makers. Hotspot publishes their requirements, so they’re worth referencing” he said.
“In other words, in practical terms, last-look doesn’t do much of anything at all when handling retail, small, or GUI order flow. If a new order is randomly submitted against a $20 spread, it’s not very probable that the order goes from being worth $20 for the maker to <$0 w/in 100ms. That’d require a fairly large jump in price for these markets, which is pretty unlikely during any random 100ms window of time” continued the senior executive.
“Put another way, if a maker were to show pricing at, say, a 0.2pip spread (typical), taker orders were randomly in time against that spread, and they maker only filled orders that appeared profitable after 100ms, I’d bet they’d probably fill >98% of orders. The 2% rejected would probably be close to 0 value anyhow, so not a big PnL impact for either maker or taker. I’ve seen first hand examples of essentially this exact scenario” he continued.
How orders are processed
Most prime of primes will either pass order flow through to the market (true STP model). Some will take the risk on board as a market maker but this is rare. At this level, order manipulation is not something that a retail trader has to worry about as order flow is taken in bulk and on an unbiased basis.
When you click buy or sell, your order is filled. In this case depending on whether or not you are trading with a tier one or tier two brokerage you have paid spread or commissions for opening that particular trade.
If the tier one or tier two broker is a market maker and running a b-book, these orders are held in house and NOT passed through up the tier/s. In this case the broker takes the risk on board and is the counter party to your trade. There are cases where the broker may only take on a portion of the order passing the remaining through to the next tier.
Where can pricing go wrong?
Reverting to the initial point made, which refers to off market pricing claims by brokers, it is possible to decipher the validity of claims such as this in unbiased way now that we understand the basic structure of order flow, pricing and tiers.
You are sitting in front of your trading platform trading. You hit the buy button on EURUSD and are filled. Depending on your platform and broker, you will be provided with a confirmation note (receipt) either on the platform, via email or on your back end reporting software.
This receipt has all the important details of the trade such as time of execution, price you were filled at and your account details and in terms of conducting a transaction, is the equivalent of walking into a store and purchasing a shirt, swiping your card and receiving a paper receipt.
One you close that particular trade, in profit or not, you will be issued another receipt with the details of that particular trade.
Your trade is closed, your orders were filled and you are away clean. After this point, there is nothing further that needs to be done, proven, or disputed.
Off Market Pricing, discrepancies and how this works, if there is such a thing!
There have been in the past extreme cases in which pricing is the most volatile and where pricing can be disputed; such as trades executed during reports of major economic news.
When news is just released, the instrument in question will likely have its value affected dramatically. Volatility then ensues and the market is extremely liquid at this point. If a trader presses the buy button and the platform lags for a second (could be a few or just a split second), the trade can then be filled.
In normal circumstances the order would have likely been slipped. It could be positive (symmetrical) or negative (asymmetrical) slippage but there is every likelihood that the order would have been slipped or requoted.
THIS IS NORMAL. This happens at the interbank level, just as it gets passed down to retail traders, largely because that price simply was not available at the particular time.
In many cases, for instance on MT4, the broker’s dealing desk has not slowed the execution down (even by milliseconds) and the trade will then often be filled at the next available best price.
This usually means that there has certainly been slippage, requoting or a widened spread, but the order will be filled and that is the end of it.
There is no off market pricing, or “ooops your trade got through at prices that weren’t available” if an order is actually filled, hence often very little recourse when asking whether the pricing was subject to slippage or requotes.
Spikes can be market related, or as a result of a technical error that causes a spike (depending on the chains, platforms, bridge provider (if any). Spikes take out the stop loss or take profit and essentially represent an error unless a very aggressive incident in the market place like a misplaced order (with a few zeros on the end) or an incident like the Swiss National Bank having removed its currency peg with the Euro in 2015.
Technical issue spikes are quickly cleaned up and in most cases within a few hours and trades reinstated or closed depending on if the trader had limit orders or was stopped out.
Naughty naughty naughty.
It has been very hard to gain corporate perspective on this matter, be it from lawyers, liquidity providers, platform providers and even regulators. This is a known practice, but due to the inability to prove it in most cases, many refuse to comment on record.
Off record, everyone knows what’s going on. If a traders is trading with a broker that has come back 10 days, 3 months or six months later when the trader attempts to make a profitable withdrawal claiming that the trader traded on off market pricing and abused their terms and conditions in turn cancelling trades (or profits), sending back only the original investment; then this is usually disingenuous.
That type of practice only proves that any brokerage operating on that principle is operating its book internally. Whilst this practice (market making or running a b-book) is not a crime and actually a profession that is well respected in the financial services business as long as it is conducted according to correct pricing, the practice of not paying profits based on the above is not respected and is, although very difficult to prove, damaging to traders and to the retail brokerage business in general.
This practice does not happen in the interbank market or at the Prime of Prime. Rather this practice happens at the b book broker side and unfortunately is not uncommon at all.
Had there been a technical mishap and a spike, trades, whether positive or negative in outcome, would be fixed and the spike removed almost instantly under normal circumstances.
What can be assumed from this as a retail trader?
There is no such thing as zero spread / zero commissions as a retail broker (tier one or two). This is as clear sign as it gets that if you are a retail trader, your orders are being processed in house and you run the risk of not being able to pull out profits.
If you see the big banks’ (Goldman Sachs, Morgan Stanley, et al) logos on a retail trader’s website, this is often a misrepresentation, as it is quite impossible for smaller retail firms to have direct liquidity relationships with Tier 1 FX dealers. Therefore, the banks are not their liquidity partners unless the broker is indeed a prime of prime. To become a true prime of prime you would need to be very well capitalized and require many millions of funds to be held at each of the banks whose logos are listed there, and FinanceFeeds can categorically assert that less than 10 genuine FX prime of prime brokerages exist globally.
In this case it is fair to say that Prime of Primes are purely focused on wholesale business and would not usually take on retail customers rather pointing them to one or more of their Tier one brokers.
If you see prolific comments and chatter online in forums and the like pointing out that a broker is indeed cancelling profits (for whatever reason) you can be rest assured that the broker is indeed running as the counter party to your trades and even just the suggestion that profits are cancelled for off market pricing is indeed bogus. Buyer beware.
At the prime of prime and interbank levels there is no off market pricing. You are likely to pay a higher spread, not get filled, or requoted / slipped in the event of extreme market conditions. You won’t see profitable orders cancelled after x period only once you submit a withdrawal for profits made.
Big offers, big bonuses and other similar marketing ploys are often a warning sign too.
Unfortunately, there are no such offers at the prime of prime or interbank markets and most likely a sign of a broker that takes care of orders in house.
Slippage is normal. The question is whether or not the trades concerned are symmetrical or asymmetrical in their slippage. If a trader has positive slippage in his favor, and clicked to buy at a certain price and the platform slipped the order and it is automatically in the green, then that is positive for the trader, however it is absolutely worth checking the terms and conditions, PDS or any other document that represents the agreement between trader and broker.
Clauses that appear fishy are most likely fishy. Any clause or wording about cancelling profits / orders that leave the decision entirely up to the broker’s discretion based on a whim are indeed a warning sign to use both legs and walk in the absolute opposite direction.