Yesterday I was in Brisbane presenting to a group of people from around Australia, several of whom were my former students a number of years ago and are now trading to make money in a full time capacity. Among the list of key subjects that I covered in my seminar was interbank liquidity and price creation, naturally some of the skilled fx traders in the audience understood what I was talking about but it was astonishing to see that allot of traders still don't realise exactly how currencies are priced. In an effort to fill in the gaps I have published this brief review.
As the majority of people that have traded forex previously know, forex isn't traded on an exchange but rather it is traded on an over-the-counter (OTC) basis. Trading over-the-counter is a brand new concept if you have traded shares in the past as no two fx brokers are going to be exactly alike, this really is very different to stock brokers who will always show you the same prices. One of the other key differences is that because there isn't a central exchange when trading forex over-the-counter there is no physical exchange of any foreign currency but rather you're dealing directly with the broker, which means once you open a position with your broker you can only close it with that forex provider unlike trading equities where it is possible to sell your shares through any stockbroker.
Now that you understand the notion that forex trading is carried out on an over-the-counter basis I'll start by explaining the basics of price formation. As a result of the OTC nature of foreign exchange a good number of transactions occur between investment banks and brokers as such they are not reported on a central exchange, it is because of this that price creation within the world of forex is more difficult, however like equities and all markets there are several main players in the forex trading world that make prices move, they are the investment banks. Banks generate prices in the course of their dealings with one another and in lots of cases they will quote prices through a system called EBS which allows one bank to see the prices shown by another bank. EBS however isn't used by all banks, what this means is that there are more investment banks dealing on prices shown outside of EBS, essentially their very own market.
So what does this all mean to you? Well this means allot if you're trading using a market maker or STP forex provider who will simply offer you a price that they get from one bank or otherwise a price that they derive themselves that is solely based on the price that they get from the bank they deal with this means you might not always be receiving a fair price. The excellent news is that there is now an alternative, there are some forex brokers that can offer you an aggregated price feed from a variety of investment banks as well as allow you to participate in the pricing formation, this means that you can place your own bids and offers amongst those presented by several of the world's biggest investment banks. Brokers offering this type of facility are generally known as ECN fx brokers.
ECN fx brokers are hard to come by and function in a very different way to traditional forex brokers. Besides the superior pricing obtainable by ECN brokers they'll always charge commission, for most traders this is unheard of however to the shrewd trader this is often a better way to trade. One of the main advantages to paying a commission over a spread is the fact that you actually know how much you're paying your forex broker, their commission isn't hidden within the spread. Paying out a commission also means more opportunity, because you're paying the natural market price you're capable of getting choice or even inverted prices something you'll never observe with a conventional broker.
Before you all send me a million emails wanting to know which company I deal with I might as well save some room in my gmail account and let you know right now. Before I let the cat out of the bag I do need to make it extremely obvious that if you look hard enough it is also possible to uncover several ECN brokers, just be sure to carry out your research before you opening an actual trading account as there are several forex brokers in existence that claim to be ECN fx brokers but are in reality market markers. I've trialled almost all of the ECN brokers and so-called ECN brokers and found that there is just one true ECN forex broker and this is also the forex broker that I personally trade with, it's Australian based broker IC Markets. IC Markets have the very best execution by a long shot and their pricing is probably the most precise that I have ever seen. As the majority of you already know I don't endorse any particular broker, I just trade with the broker that I believe has the most competitive foreign exchange offering and most transparent pricing and that provider is IC Markets.
As the majority of people that have traded forex previously know, forex isn't traded on an exchange but rather it is traded on an over-the-counter (OTC) basis. Trading over-the-counter is a brand new concept if you have traded shares in the past as no two fx brokers are going to be exactly alike, this really is very different to stock brokers who will always show you the same prices. One of the other key differences is that because there isn't a central exchange when trading forex over-the-counter there is no physical exchange of any foreign currency but rather you're dealing directly with the broker, which means once you open a position with your broker you can only close it with that forex provider unlike trading equities where it is possible to sell your shares through any stockbroker.
Now that you understand the notion that forex trading is carried out on an over-the-counter basis I'll start by explaining the basics of price formation. As a result of the OTC nature of foreign exchange a good number of transactions occur between investment banks and brokers as such they are not reported on a central exchange, it is because of this that price creation within the world of forex is more difficult, however like equities and all markets there are several main players in the forex trading world that make prices move, they are the investment banks. Banks generate prices in the course of their dealings with one another and in lots of cases they will quote prices through a system called EBS which allows one bank to see the prices shown by another bank. EBS however isn't used by all banks, what this means is that there are more investment banks dealing on prices shown outside of EBS, essentially their very own market.
So what does this all mean to you? Well this means allot if you're trading using a market maker or STP forex provider who will simply offer you a price that they get from one bank or otherwise a price that they derive themselves that is solely based on the price that they get from the bank they deal with this means you might not always be receiving a fair price. The excellent news is that there is now an alternative, there are some forex brokers that can offer you an aggregated price feed from a variety of investment banks as well as allow you to participate in the pricing formation, this means that you can place your own bids and offers amongst those presented by several of the world's biggest investment banks. Brokers offering this type of facility are generally known as ECN fx brokers.
ECN fx brokers are hard to come by and function in a very different way to traditional forex brokers. Besides the superior pricing obtainable by ECN brokers they'll always charge commission, for most traders this is unheard of however to the shrewd trader this is often a better way to trade. One of the main advantages to paying a commission over a spread is the fact that you actually know how much you're paying your forex broker, their commission isn't hidden within the spread. Paying out a commission also means more opportunity, because you're paying the natural market price you're capable of getting choice or even inverted prices something you'll never observe with a conventional broker.
Before you all send me a million emails wanting to know which company I deal with I might as well save some room in my gmail account and let you know right now. Before I let the cat out of the bag I do need to make it extremely obvious that if you look hard enough it is also possible to uncover several ECN brokers, just be sure to carry out your research before you opening an actual trading account as there are several forex brokers in existence that claim to be ECN fx brokers but are in reality market markers. I've trialled almost all of the ECN brokers and so-called ECN brokers and found that there is just one true ECN forex broker and this is also the forex broker that I personally trade with, it's Australian based broker IC Markets. IC Markets have the very best execution by a long shot and their pricing is probably the most precise that I have ever seen. As the majority of you already know I don't endorse any particular broker, I just trade with the broker that I believe has the most competitive foreign exchange offering and most transparent pricing and that provider is IC Markets.
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