How do FX dealers really work inside?

Hi all,

To be a good trader I need to understand not only the markets, but also how forex dealers really work from the inside out (at least as long as I stay with them).

I never had a job in one of those companies, so here are some answers I'd really love to find:

1. Why do forex dealers require a distance of, say, 80 pips, to set a stop loss? How do they benefit with that?

2. In a variable spread world, do they set a spread system-wide, i. e. equal to all customers at the same time, or on a per customer fashion, shaping their customer basis?

3. What kind of functionalities does a server-side dealer system has and what do they like to see in their "crystal ball"?

4. How does a dealing desk work? Is there a humam matching, like, people manually taking the biggest orders or so?

5. Is the 'Beat the Forex Dealer' book reliable or just some partial/paranoid vision?

6. What's really going on in the preeceding minutes when a market closes and/or another opens? Why so often you notice that in the charts only 5-8 minutes later?

7. What would be the profile of a good dealer customer? One who loses slowly?

8. Why some dealers try to avoid scalpers, if they would - in theory - generate more revenue to the house? And, those who accept scalpers, do they really like them?

9. Do they sell or share (real-time) statistical data (our stops, for example)?

10. Is stop hunting just the favourite lame excuse of the amateur trader, or are there proven facts that a few/some/all dealers manipulate spikes for a quick profit?

(If you don't have answers, then why not adding some good questions here and maybe some generous t2w fx gurus will answer a few?...)

Thanks !!!!!

As nobody has posted an answer yet I will offer a few ideas on just a few of them (but not from any inside knowledge):

1. It reduces the load on their systems as customers won't be adding and deleting orders in response to every slight market movement. It prevents customers managing to get out at a slightly better price by taking advantage of slight "noise" movements filling near-to-market limit orders. It encourages customers to use market orders which are easier for the M/M to deal with to their advantage.

7. One who frequently blows their account and keeps reloading it every time. But that class of customer usually gives up after a few tries. A good category of customer are those who trade large size and win over time. The M/M just has to pass their orders into the real market and make sure they have a mark up of at least 1 pip per round turn on average to give them a regular return for servicing that account.

8. Has been discussed frequently here before. They don't want their net book position having big changes which quickly reverse back to the original position - since it's very unlikely that other customers will establish an opposite direction position during that short period of time. If their net book position change is large enough to require them to hedge (to meet their risk limits) then they are likely to have to remove that hedge just seconds or minutes later adding to their costs.

Perhaps somebody who has worked in a retail M/M can offer answers to some of the other points especially 2, 3 and 4.

So many questions... Hopefully, GammaJammer is on hand to share his wisdom.

gc1 & Martinghoul, thanks so much for your replies

Now I see that a good customer must be the one who doesn't use leverage at all and, as you say, wins consistently placing large trades.

This kind of customer must be rare, as these people can be just switching money between regular bank accounts in different currencies instead of being with a typical retail M/M...

Schopen said:

Like to see if I understand this correctly: If I use max leverage (and win) my broker loses their spread profit and their P&L gets hit. If I use no leverage at all and win, my broker gets to keep their spread markup and it's only the MM they hit with my order that loses?

Click to expand...

I don't see what leverage has to do with whether the dealer makes money or loses.

(sorry, deleted the post then saw that you answered so er, put it back in)

Like to see if I understand this correctly: If I use max leverage (and win) my broker loses their spread profit and their P&L gets hit. If I use no leverage at all and win, my broker gets to keep their spread markup and it's only the MM they hit with my order that loses?

Schopen said:

(sorry, deleted the post then saw that you answered so er, put it back in)

Like to see if I understand this correctly: If I use max leverage (and win) my broker loses their spread profit and their P&L gets hit. If I use no leverage at all and win, my broker gets to keep their spread markup and it's only the MM they hit with my order that loses?

Click to expand...

I don't understand why this would be the case...

Ummm I suppose not. Margin means no matter what your leverage if you are wrong only you lose money, and the bigger your leverage the faster that will be?
If you are right, no-one loses except the end MM..

So where's the motivation for shady practices alluded to in books?

Schopen said:

Ummm I suppose not. Margin means no matter what your leverage if you are wrong only you lose money, and the bigger your leverage the faster that will be?
If you are right, no-one loses except the end MM..

So where's the motivation for shady practices alluded to in books?

Click to expand...

Someone loses somewhere in the mkt, but it may not be the end MM either, as they would likely offload the trade as well.

What shady practices might you be referring to?

Martinghoul said:

What shady practices might you be referring to?

Click to expand...

Stop hunting, shading prices, 'disabling' their system during volatile markets, going back on a previously confirmed price, selling customer stop info to other market participants, delaying customer orders until the price suits them better - that is, if you believe everything you read.

Schopen said:

Stop hunting, shading prices, 'disabling' their system during volatile markets, going back on a previously confirmed price, selling customer stop info to other market participants, delaying customer orders until the price suits them better - that is, if you believe everything you read.

Click to expand...

Ah, yes, all of these things do happen, but they have more to do with the micro-structure of real dealing, rather than the ideal stylized case we are discussing.

In general, think of it this way. When everything works as it's supposed to, everyone manages to hedge their exposure at every step of the way and earns their little piece of the pie. However, in the real world, things go haywire, people take shortcuts, liquidity in the mkt disappears, etc... When these things happen, a dealer or the client would sometimes be left holding the bag. All the shady things you've read about are about who takes the hit.

Here's a thought: If I use maximum leverage does the broker take a bigger cut in terms of the spread as opposed to the exact same trade using no leverage?

Bigger size position for you means larger pip values for the dealer which means higher profits on the spread.

Thanks.

I don't mean to hog the thread but I also have a question about:

gc1 said:

Q. Why some dealers try to avoid scalpers, if they would - in theory - generate more revenue to the house? And, those who accept scalpers, do they really like them?

A. Has been discussed frequently here before. They don't want their net book position having big changes which quickly reverse back to the original position - since it's very unlikely that other customers will establish an opposite direction position during that short period of time. If their net book position change is large enough to require them to hedge (to meet their risk limits) then they are likely to have to remove that hedge just seconds or minutes later adding to their costs.

Click to expand...

I thought from what I've read so far that FX brokers only worry was to aggregate their client orders to a sufficient size that they can offset in the interbank market. When you say 'net book position' are you talking about hedging their client trades or interbank trades? or are they one and the same book?

Schopen said:

When you say 'net book position' are you talking about hedging their client trades or interbank trades? or are they one and the same book?

Click to expand...

He means when you net out all offsetting customer positions the exposure the broker has remaining.

brokers make money from people trading so its in their interests to trigger orders as that gains them commissions. so where are the orders? and who knows where they are? with automated software that shows the p/l of triggering them?

algos increasingly dominate the markets making them so fast on the small time frames as to be untradable for a human for any length of time.

people trading under and with no view of the day, 4h ,1h are asking to for trouble.

one of the big myths is that there are people who know stuff you don't know. plenty of pros fail at trading forex . basically its a game between central banks. between people who think several months ahead.

Yesterday I asked a GFT guy if they prefer or avoid some type of trading style.

He said there's really no problem nor preference if a client does a one minute scalping or stays in a position for several days.

I tried to catch some kind of bias but he only asked for fair play, as there's one or more obscure ways to explore a dealer's system for illicit profit.

My goal is to get a solid understanding of a dealer's inside mechanics and also the interbank mechanics.

That's because IMHO a trading strategy cannot be realistic and fully maximized if a clear knowledge of this kind is absent.

When oiltanker says «basically its a game between central banks. between people who think several months ahead.», I think that's a big key point, because part of wisdom is also to understand their psychology.

For example, few people talk about yield curves, maybe one of the most important indicators for the bank guys:

Understanding the Yield Curve | Investing Basics | Stocks

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