How Can the FOREX Trader Become Transparent to the FOREX Broker?
A FOREX trader would prefer to be transparent to a FOREX broker if the broker is running a Dealing Desk, called DD, because any information gleaned by the broker about a trader's intentions can be used against the trader. A DD broker is a market maker, which means it controls the bid/ask spreads and order executions for its clients. Often, such brokers take the other side of their clients' trades: if a client wants to buy a certain currency pair (currencies always trade in pairs), a DD broker will sell it from its own inventory. This sets up a conflict of interest.
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Conflict of Interest
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It is important to remember that FOREX trading is a zero-sum game -- on every trade there is a winner and a loser. If you trade with a DD broker, you are trading with your opponent. The problem is, unless you take precautions, the broker will know your intentions as to what prices you plan to buy and sell currencies. It thus will be constantly tempted to manipulate prices and/or spreads to ensure your trade is the losing one.
Typical Orders
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Your DD broker will know your intentions by the limit orders you place. There are three types of such orders that tip the traders hand:
1) Limit buy or sell order: The highest bid or lowest ask price at which you are willing to transact. A limit order waits in limbo until market prices reach the limit price, at which point the limit order becomes a market order, executable at any price. One form of manipulation is for a DD broker to issue a quote at the limit price, but then fill your order at a less favorable price.
2) Stop-loss order: The maximum loss you are willing to sustain on a trade. A DD broker could "anticipate" the stop-loss price prematurely, causing you to be saddled with a loss which you might have avoided.
3) Take-profit order: The minimum gain you are willing to accept. A DD broker might depress its quotes to keep prices just below your take-profit price in the hopes that prices will reverse quickly and your trade will not succeed.
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Strategy for Transparency
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The naive response to potential DD broker malfeasance is to not place limit orders. However this imposes its own set of risks. For lack of a stop-loss order, you could be hurt if prices move against you severely and quickly -- you would have to be aware of such a situation in real-time and immediately place a trade. Sooner or later this strategy will fail and you could rack up a big loss. Lost potential profits are a similar consequence of failing to use a take-profit order.
Achieving Transparency
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You achieve transparency by using a FOREX robot -- trading software that monitors realtime prices and that places trades on your behalf. You can program in the three limit trades and have the robot execute them as market orders at the appropriate prices. The DD broker will have no warning of your intentions, and is thus less able to plan against you. Of course, a perhaps better alternative is to use a Non-Dealing-Desk, NDD, broker instead -- they don't trade against their clients. Another class of FOREX brokers, those who use Electronic Communications Networks, or ECNs, to transmit orders to the FOREX marketplace, are NDD and never trade against their clients. You might consider switching to an ECN broker and avoid the transparency issue entirely.
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References
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