Not All Brokers Are Bucket Shops

Forex (Foreign Currency Exchange) traders invest a great deal of time wringing their hands and talking about their various uncertainties about the retail brokers they use to execute their money. It's natural to presume that to make money in Forex simply means to 'beat the market' by finding and executing good quality trades. The truth is, there is so much more to it; the company which is executing your trades can definitely impact your success.

Many people stay away from what are called Bucketshops; agencies which give questionable prices, seem to manipulate them for their own gain, and actually work to the detriment of their clients. Few brokers will admit to doing such a thing, primarily due to the undeniable fact that it provides them a strong incentive to make their clients lose. Another term commonly used for such agencies is 'Market Makers'. Due to the fact that they give their own price values and accept the customers' trades directly from their own trade inventory, they are undeniably making the market. A truthful examination of the currency world, though, lets us see that this policy is truly necessary to letting small retail trading to occur, and though it As unsettling as such facts may may be, small capital trading would be unfeasible in the absence of there kinds of methods, and not all brokers employ them to defraud their customers.

The reason for this is due to the fact that there is no physical 'Forex market', in the sense that there is with other varieties of investment. To demonstrate this, company stocks are bought and sold only on brick and mortar stock exchanges -- the NYSE being among the most prestigious. Exchanges such as these are governing agencies who qualify each company to be listed, define the specifics of the stock trading contracts, regulate brokers, and ultimately clear all trades financially. They have a specific location, do business at known hours and have the authority to close down trading of any and all stocks or the trades of any and all brokers they have reason to believe are acting illegally or in such a way that impedes fair and legal trade.

The Foreign Exchange market, however, is made up primarily of giant organizations that have a need to exchange money with other countries. The actual Forex market consists of giant global businesses and worldwide banks that shift funds from place to place for the purpose of facilitating global trade. When a company located in Japan sells goods to an American company, it will probably get its payment in the form of $US, but it must pay its own bills as Japanese Yen, so it must be able to change significant amounts of currency on a continual basis. This is the real Forex market; corporations and banking institutions who move trillions of dollars worth of currency to and fro on a daily basis. Small potatoes traders like us could never get into that arena -- we simply don't have enough capital.

Because of this a Forex broker needs to be free to trade currency straight across with their clients. These brokers are willing to take in smaller trades of the variety we can do, and they can lump them together. They then do larger offsetting trades on the open market via arrangements ironed out with 'Liquidity Providers'. The large banking institutions are able to trade with an agent that represents many retail traders even though they would not ever consider trading with every individual. This simply wouldn't be reasonable for them.

As a result, the trader depends on her broker to publish their own currency prices instead of getting a unified value from an official exchange. Each brokerage does trades with their specific banks and different brokerages are likely to utilize different liquidity providers. That is why two different agencies very rarely offer the exact same prices. It is not a scheme to screw the clients (although there will be those who do) but simply a necessity of creating the market for you to participate in. A broker may be honest but still have the need to trade against its clients, even if they're not trying to falsify price quotes and cause those clients to lose.

So, to sum it up, we see that many retail brokerages are required to take the opposite side of all but the biggest of their customers' trades, however they should not take advantage of this to aggressively trade to make them lose. With such circumstances a Forex speculator or anyone wanting to learn Forex needs to watch out for his or her own interests. All speculators should consciously choose the broker they use and should actively monitor the trade and quoting activities to ensure that they are getting dealt with equitably. In reasonableness, however, each trader must recognize that their broker must trade opposite to them and they shouldn't assume a nefarious design. It is an inescapable, though uncomfortable aspect of the retail foreign currency exchange business model.

By: B. Keith Dalton

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B. Keith Dalton has been studying Forex for years, using his experience in science, computer programming and statistical data analysis to help him understand the often confusing and chaotic world of Foreign Currency trading. You can read his blog at Money Pipeline. He writes and sell Forex indicators and trading systems at www.tantalusonline.com.