A Forex broker is legitimate as soon as it gets licensed by the relevant supervisory body in their country of residence.
Forex, as a financial market, demands two parties. You cannot execute a trade without your counterparty. If you win money, someone else loses, and that is the rule of thumb.
Retail brokers are usually the counterparty in the Forex market which means that you trade against your service provider, i.e. your broker. The broker is your liquidity provider, and the broker dictates the limits of the market access. You only purchase from your broker, and you only sell to your broker. They decide the prices of currencies and spreads.
To make a profit, they count on the spread between the ask and the bid price. You are, on the other hand, better off with narrower spreads. If you make a profit, your broker has to pay you, and if you lose, they can take money from your account, which means that conflict of interest is a part of this business.
The business is very similar to bookmaking. Chances are greater that traders will lose their money then make profit and retail brokers use it to their advantage.
Retail brokers are not suitable for experienced, real profit-makers who know how the business goes down. The retail brokers that have a great reputation will pay out such investors but very reluctantly. Retail brokers actually do not have the assets to keep up with profitable traders. They are more suitable for causal traders, where they are not exposed to the risk of loss. If they happen to be in such a situation, they resort to tricks like re-quoting, sloppy execution, platform troubles, etc. to stop their loss (or their trader’s profit).
Playing in the Big League
As a serious trader who wants to avoid being played by your broker, you should look for brokers whose profit is not dependent on your loss. This means that there is no direct link between your assets and their profit making.
You can join the Electronic Communication Network (ECN), an online system that represents the link between brokers, liquidity providers, and retail traders. The ECN broker is electronically run and has no dealing desk (opposed to retail brokers or market makers).
Liquidity providers are usually big banks, and the broker’s platform is usually directly connected to their platform, whereby the trades are executed against the liquidity provider, not the broker.
The ECN brokers normally make sure to have more liquidity providers to offer lower spreads to customers. The system automatically connects investors with the best quotes. The trade is directed to a third party, and the broker does not interfere.
The third party is the actual counterparty you trade against. In this case, it is the liquidity provider (mostly a bank).
In some broader sense, it can be said that you and your broker are on the same side. You act on behalf of your broker against the liquidity provider that your broker linked you to.
Your broker is the intermediary who takes money from the liquidity providers if you make a profit and in the case of loss your broker refunds the liquidity provider at your expense. Your no retail broker retains a neutral position regardless if you win or lose money.
What’s the Catch?
So far, you’ve just gotten to know the process of how you make money, but right about now you are probably asking yourself how does these no retail brokers make money if they nothing to do with the way you trade?
There are two options: markup and fees.
Talking about the markup option, brokers simply add a markup to the spread. Besides the pip-points added by your liquidity provider, the broker can add a pip point for their benefit. For example, if your liquidity provider has a spread of two pips and your no retail broker adds one more pip, then your spread will be as wide as three pips.
If you move up 50 pips, your win will equal 47 pips, while the remaining pips represent the spread – where one pip goes to the broker and two to the liquidity provider. In the opposite case, if you go down 50 pips, all parties involved make a profit except you. You will lose 53 pips. If you lose your broker still wins that one pip, while the liquidity provider wins the 50 plus the two-pip spread.
The other option for no retail brokers is to charge a fee for their services without adding pip-points to the official spread. The commissions can take a number of forms, sometimes balanced out with the markup option.
Your ECN broker cheers for you to win because their profit depends on the volume of their customers’ trades. Naturally, the more you win, the more you will invest, which is advantageous for your broker.
This kind of broker is also suitable for big-time traders. The broker makes money when you make money with no conflict of interest.
These brokers are highly recommended since your funds are safer, and there is no conflict of interests. It is better to pay additional fee or a wider spread than to risk losing your money and the battle against your retail Forex broker.
Always choose to be on the same side as your broker if given the opportunity.