FXCM launched a new web site this week. The company shifted its marketing strategy to emphasize lower trading costs. The lower spreads, however, come with a catch. The trader must choose to trade either on a dealing desk or using pass through execution. Leaving the account on pass through execution means paying a whole extra pip on trades.
Dealing desks mean that the company chooses to take risk against its clients. When Joe Trader goes long the EURAUD, the dealing desk simultaneously goes short by selling Joe Trade the EURAUD. Most people forget what a trade is because of the electronic trading environment. It’s easy to associate clicking buttons with “stuff happening” afterwards. Nonetheless, it’s important to remember that you are trading. That is, you are exchanging currencies with someone. A trade is impossible to do without that other someone.
The risk of trading through a dealing desk is that the broker perverts its incentives. The job of a broker is to ensure that his client receives quick and satisfactory execution on all orders. When a company like FXCM chooses to also act as the counterparty to the trade (i.e., a dealing desk), those goals are in direct conflict with the client. Poor execution directly harms Joe Traders while directly benefiting FXCM.
That’s the risk. The vast majority of the time, dealing desks provide quick and appropriate execution to their clients. Egregiously abusive practices would lead to clients closing their accounts and bad mouthing the company all over the internet. The degree to which brokers indulge in questionable execution on trades obviously varies heavily from company to company.
Dealing desks hate scalpers and scalping expert advisors for two reasons. Scalping involves opening and closing trades within a short period of time, usually within a few minutes. This causes headaches for dealing desks because they need to manage the net risk of all open orders. Joe Trader opening and closing microlot trades causes very little harm to the dealing desk. When there are 500 other Joe Traders doing the same thing, however, it becomes a hassle. The net exposure of the order book fluctuates from minute to minute, usually to the dealing desk’s short term disadvantage.
Scalperes work to the advantage of the dealing desk over the long run. Scalpers pay an absolute fortune in spread costs, which quickly and silently drains the account of its equity. Scalpers tend to go through lengthy periods of picking up pennies consistently every day. Then the steamroller comes along and flattens them and the little gains that they accumulated. The dealing desk bleeds while those pretty equity curves are drawn. Then, when volatility picks up, the desks make out like bandits as huge percentages of scalpers start blowing up. The dealing desk earns exactly as much as the destroyed scalpers lost.
Despite the long term advantage, the desks hate watching the equity drain slowly everyday. The common tactics result in price shading, poor execution and dealer intervention where the dealing desk outright refuses to close the trader’s position. If you like scalping the markets, trading on a dealing desk is not a good idea.
Traders with average holding times in excess of four hours might consider trading with a dealing desk given an appropriate incentive. FXCM now offers a fairly compelling reason to seriously consider the idea. Despite all the breathless criticism of FXCM across the internet, my primary gripe with the company is that they charge an outrageous amount of money. Their spreads are consistently higher than every other major brokerage. I consistently see them charging 2.6 pips on the EURUSD, yet their interbank feeds run average spreads around 0.5 pips. Charging a 400%+ markup is outrageous.
The new dealing desk offering reduces the lowest possible spread to 1.5 pips. That one pip of difference takes FXCM from being one of the most overpriced in the market to offering one of the lower spreads available among major brokerages. The spread pricing is far more reasonable and offers the opportunity to trade with a reputable company.
I am comfortable endorsing the idea of trading on FXCM’s dealing desk so long as the traders holds his positions for at least several hours. Although it comes with obvious disadvantages and conflicts of interest, those factors are much less likely to apply to a trader the longer that he holds a position. Carry traders and those with multi-month holding times have the least reason to be concerned. Trading with a dealing desk in exchange for a 40% discount in trading costs is worth it.
Scalpers should avoid the setup. No dealing desk wants scalpers on its system. I’m told that FXCM will push scalpers who trade on the dealing desk automatically onto pass through execution, which FXCM refers to as NDD (no dealing desk). Scalpers can maintain the dealing desk pricing but are secretly switched onto FXCM’s NDD feed.
Nonetheless, I feel that the conflict of interest is to great for this category and that traders should not rely on the company’s unwritten policies for decent execution. Scalpers at FXCM are better off trading on the NDD feed. Better yet, scalpers should find a broker with pass through execution that charges reasonable spreads.
If you trade six figure balances and/or do a lot of trading volume (more than 100 million notional) and are concerned about trading costs, please contact me directly at email@example.com. OneStepRemoved.com is not an introducing broker and does not receive rebates on its referrals. I am happy, however, to introduce readers to companies and introducing brokers that offer trading costs under 1 pip and without any spread markups.