Card Stacking

Retail participation in the FX market is nothing new. Before the advent of the cum, Europeans were accustomed to dealing with foreign exchange all the time, and anyone who has lived in a country with a volatile currency will tell you that
they always like to keep one eye on the exchange ratc. In the UK, spread-belting shops have long offered "punters" the chance to bel on exchange rates I and in Asia
"Japanese housewives" and their $ 10 billion of daily trading have been the bane of market professionals for some lime, yet the real explosion in on-line currency trading thaI we have seen in the last five years can be directly attributed to the deregulation in US markets.
Throughout the 1990s, US futures exchanges complained to the government that they were drowning under a mountain of red-tape and outdated reponing measures. which increased their transaction costs and stifled their growth. In order to help the exchanges streamline their operations, the CFrC2 passed the Commodity Exchange Act and Commodity Futures Modernization Act (CFMA). Under the CFMA, over-the-counter markets were kept exempt from US government oversight and some of the more restrictive regulations on futures exchanges were removed to ensure their global competitiveness. This, combined with the internet revolution, opened Ihe doors for FX brokers (also called FeMs) 10 largel a relail audience and begin offering on-line margin trading accounts. Retail FX brokers thus gained legilimacy by placing Ihe "regulaled by Ihe NFA" logo on Iheir websile, and Ihe power of the internet meant that these start-ups needed little more than a Reuters line and a toll -free number in order to compete with traditional brokerage houses.
The early years of the retail FX market featured a number of rag-lag outfits con¬sisting of over-caffeinated dealers in liny Manhattan offices offering their clients spreads wide enough 10 drive a truck through, and mosl would surely have contin¬ued to live an uneventful life had it not been for the collapse of the internet bubble.

With the burst of the bubble, FX brokers now had what they had been lack ing all thi s lime: a client base in love with day trading that was dying to try something different. The three or four firms that recog nized this opportunity and focused all
of their anemian on their marketing efforts quickly became the market leaders and
have never looked back.
These retail operations that have mushroomed in the last five years sit in a
slill-to-be-defined gray area within the FX markel. In theory Lhey should act as little more than middlemen between the true interbank market and their retail client base. but unfortunately because of the nature of the FX market and the lack of regulation some of these outfits bring to mind the unscrupulous "bucket shops" that operated in the early part of the 20th century.
In a time when stock market euphoria was gripping the nation. the typical bucket shop of the 1920s catered to the small investor with big dreams but lillie market experience. All of the transactions they handled were off-exchan ge (with the firm taking the other side of all trades). and in order to increase speed customer orders were simply taken at the counte.-3 and dumped into a "bucket". to be matched and filled at a later point. Because the orders where not immediately olrset in the market, the shops could either wait until the price moved in their favor before filling them (keeping the difference) or wait until the end of the day 10 match buys and sells at their own "adjusted" price. The dealers that ran the shops knew that in a time of delayed quotes and nontransparent pricing, clients had lillie way of knowing where the market stood at the exact moment they placed their orders. and thus they would likely be satisfied as long as their orders were filled within the high/low of the day. Because of these ad vantages. bucket shop operators found it relatively easy to shade prices and take large chunks fro lll both the buyers a nd the sellers.
Unfortunately, tod ay's retail FX brokers share many traits with these outlawed operations, including:
Nontransparent pricing. The FX market is an over-the-counter market, meaning the price your broker gives you is (he price you get. You have no choice in the matter. Pricing is not done through a central exchange. so it may be difficult for the trader to determine if their broker is quoting them "fair" prices or if they are shading the price in their favor.
Encouraging overleveraging. Like the bucket shops. retail FX brokerage firms prey on (he small, unsophisticated investor. By extolling the virtues of 200•1 lever• age. traders are encouraged to overexpose themselves and be qui ckly wiped out by small price moves.
Trading against your clients. It is standard practice in the FX world to trade against your client base. Retail trade sizes are too small to be immediately offset in the interbank market. so your broker is rorced to take the opposite side of the trade, at least temporarily. The broker may then wait until the client flow is surficient to orrset with their market maker or Ihey may choose to hold the position and effec tively trade against their clients. A "no dealing desk" policy simply means that dealers have been replaced with machines.

The simple answer is "no". Since statistics show that most traders blow-up their accounts before reaching their first anniversary, it is in a broker's best interest to gel as much as they can as quickly as they can. There is no such thing as a "long-term" relationship between a market maker and his clients, and while the degree of dodgyness may vary from shop to shop. the capital markets were fou nded on greed, not charity. Stories of big investment banks ripping off large corporate clients routinely make the news, so is it really any surprise to hear that retaillraders do not fare any better? Since dealers routinely change jobs and live on a daY-la-day basis (or bonUS-la-bonus, actually) it should come as no surprise to learn that they focus purely on short-term profits. A trade is a trade and a deal is a deal, so do not expect any sympathy from your broker/dealer anytime soon. Arter al1. he is not exactly selling ladies shoes, either. A dealer's job is a risky one, and he knows that if you could. you would probably rip him off in a second, so why should he treat you any differently? Although I am sure squeaky-clean shops exist somewhere, I have yet to come across any.
MARKETING MACHINES
Traders have to realize that behind all of the smoke and mirrors retail FX brokers are, above all, marketing machines. The more accounts they open, the more money they make. Because the average survival rate for traders is so low, in order to survive they need a constant How of new or returning clients, and although some brokers may claim to have over "50K+ clients" in reality the vast majority of those accounts have been dead for quite some time. The actual figure is probably closer to a 10 % retention rale, and even the people running the trading houses have no problems discussing the dreadful odds their c lients face. According to Drcw Niv. chief executive of FXCM, "If 15 % of day traders are profitable, I'd be surprised.'"
To secure this constant How of clients, brokers spend vast amounts of money on marketing schemes that I am sure you have been the target of in the past. They will try everything from huge internet advertising campaigns to direct mail offerings, even going as far as holding trading "conferences" or "seminars". In the end. you can rest assured that they want a return on their investmcnt: your money.
Take, for example. their much-hyped "forex trading contests" that promise to reward the bcst traders with monthly cash prizes. What could possibly be wrong with rewarding good traders? A lot, actuall y. Trading contests and dreams of a large payoff place people in direct competition with each other. which, as you may know, tends to only encourage risk taking and lead to terrible money management deci¬sions. If you are trading to beat your neighbor. not simply to make money for your own account, then you can rest assured that you (and your neighbor) will soon find yourself broke. Even if we manage to put aside the ethical dilemma these contests.

Since retail FX brokers do not have to offset client transactions in an exchange, pricing decisions become critical. Large retail FCMs have their own market makers, a Citi or Goldman for example, which offer them a I pip spread or less on the most liquid pairs, which they use as their indicative price. To this rate, they add their 2 or 3 pips (or more!), which is the rate clients see in their trading platforms, which enables them to capture a nice 3 or 4 pip risk-free profit on a round-trip trade ¬not bad for simply acting as the middle man between the FX "wholesalers" and the rctail buyer.
However, because these middlemen are free (0 manipulate their price feed, they can essentially show their clients any price they want, and the same person that is doing the buying and the selling also becomes the person that controls the prices. If this smells fishy to you, it should; after all, it is the primary reason why exchanges were created in the first place, since the lack of transparency always plays into a dealer's hands.
Price shading occurs when a broker either deliberately stalls their price or shows Slightly higher/lower rates in anticipation of a move. If a broker is convinced that the curo is going higher, for example, he will shade his quotes slightly higher to benefit from the move. This is all fairly common practice in the FX world. yet even morc appalling manipulation takes place when brokers deliberately spike their feed in order to take OUi customer orders. If a dealer notices that a bunch of good-sized stops have gathered nearby (remember, they know where your stops lie!), he may choose to mOllnt an attack on them with his buddies or momentarily spike his price feed just enough to take them oul.
Naturally, the move will be seen as single blip. not enough to be traded on, but enough to trip the client stops. If a client complains, brokers are shielded by the fact that there is no central exchange from which to compare second-by-second pricing. and are free to offer up any excuse for the move: "There was a large order that pushed through the market" or the classic "Our feeds are faster and reflect true interbank movements," In reality whal they are dying to leil you is, "Thanks for noticing; that was a great move! We nailed you!" I'm sure most retail traders have experienced such infuriating behavior. but the nature of the market makes it hard to enforce such downright fraud ulent actions.