Over the last several years, Forex Dealers have been springing up everywhere. Attending the New York City Trader's Expo this year, I was surprised at the number of FX dealers that were all exhibiting very similar offerings. Some competitors even used the same trading platform just white labeled to appear customized.
My thoughts were there must be tremendous profits in the FX Dealer business to support the preponderance of dealers offering truly non-differentiated offerings.
My next obvious thought was, where does this profit come from? These guys generally do not charge commissions, so how do they get paid?
Dealer profiting - your Loss is their gain
They make their money in several ways, first is from the bid/ask spread which normally is at least 2 pips and sometimes as high as 5 or 7 depending on the dealer.
The second way and some say the sneaky of dealer profiting is to actually take the other side of your trade. Your losses go directly into the dealer's pocket.
How is this possible? A little known fact about trading with FX dealers is that your trade isn't actually placed in the true interbank market, but merely held on the dealer's own books. They are the counterparty, therefore your losses enrich the dealer and your gains come directly from the dealer. Conflict of interest? I'll let you decide.
Dealers are improving; however, some are moving to a non-dealing desk model and having several banks compete for your trades with the best price on the pair. You are trading with the dealer as your counterparty in an unregulated marketplace - seems pretty risky for the serious trader.
Is there an alternative for the active currency trader?
Yes. There is an excellent alternative in the form of currency futures offered by the CME. I am particularly partial to the E-mini version of the currency contracts from the CME.
The E-Mini Euro symbol E7 is the one I am most familiar with. It moves in $6.25 ticks and the advantages of trading this future over the EUR/USD pair offered by dealers are several. First and foremost is the very tight spread and low commissions offered by most brokers.
Secondly is a regulated marketplace with price transparency.
Thirdly, your broker can't play games with your trades as dealers sometimes do, as the trade is made in the actual marketplace and not held on dealers' books.
The bottom line
FX dealers offer more flexibility for the FX trader, particularly small traders. They provide access to the market for those very little capital. In fact, several even allow you to trade micro lots with just one dollar in the account! The spreads and other negatives have less of an impact if you're a longer term or swing trader.
Currency futures definitely have the advantage for short term/day trading/scalping. In the end, it really comes down to personal choice and style.
Good Luck!
Dave Goodboy is Vice President of Marketing for a New York City based multi-strategy fund.
