Delusional Transparency: Spread, Liquidity, and Slippage

It is widely accepted that the forex market is highly transparent because not a single institution or individual is capable of manipulating the market, such as spoofing, which is more likely to occur in the futures market. Even George Soros failed when he targeted to create a financial crash in Hong Kong previous to the city coming back to China in 1997. Taking his opportunity, Geroge Soros did an intervention that came out in volatility in Hong Kong's shares and forex markets, but Soros was defeated by the bank of Hong Kong.  

Forex trading pairs seem to be better executed than stocks, options, and commodities. But that is what your brokers want you to believe. Does your broker manipulate your trades? Can your broker ensure your trades are executed at the bet prices?

In-transparent Unwritten Rules

Recenly, Eduardo G. Delgado, director of Fintexify, posted on LinkedIn, pointing out that forex brokers cannot provide the promised ultra-low spreads to retail traders when executing trades.

To make it simple, forex brokers are using "sales pitches" to attract clients as the spread can hardly be achieved. In practice, slippage is very like to occur at those prices due to low availability of liquidity. A large slippage, which is more than often, offsets the advantage of an ultra-low spread, which only applies to a small proportion of trades.

It reminds me of the sign board in shops. It writes "starting from $9.9" to lure you in the store, but later you find out the $9.9 item has been sold out, and the rest of the goods start from $999.

Did the shop lie to you? No. But what benefits can be brought to the customer?

Other than failure to deliver the ultra-low spread as claimed, traders may also suffer from slippage caused by last look when dealing with A-Book forex brokers. Last look refers to a trading practice where liquidity providers offers a quote rather than a firm price into the trading system or execution venue.

When a request to trade against the quoted price is received, the LP may hold the request for some time, execute the trade at the price quoted, offer an alternative price (requote) or decline to trade. Last look's quote-driven behaviour is commonly argued to be necessary to protect the liquidity providers in a fragmented and unregulated market place where there is no central exchange.

For example, if Liquidity Provider A placed buy limit orders for 10 lots of EUR/USD at 1.3500, and a trader decides to sell 10 lots of EUR/USD at 1.3500, then the two trades would be a match. However, the last look enables Liquidity Provider A to reject the trader’s order within 200 ms, in which case the order will be filled at a second-best price, e.g. 1.3499, causing a slippage of 1 pip.

The Game of Transparency and In-transparency

Eduardo's post received many replies.

Marcin, trading software specialist at TraderEvolution, is in favor of market depth to increase transparency:

"It is a quite complex topic. Let's start with the fact, that most retail traders need (and certainly want) rather good prices than big sizes. At the same time, most of retail traders do not understand (nor bother to learn) how order execution look like and what happens when they send an order from a front-end application. Most common way to think about it is that what price they see is the price they get. Further they realize that it's not exactly like that so they start thinking about their broker also in execution quality terms.

Then from the brokers' angle it's basically a business tactic to respond to what traders want, and to deliver it at the lowest cost. It may feel unethical, but brokerage business (as a whole) is rather amoral by default. Should regulators force brokers to deliver the exact price which they offer on the screen to their retail clientelle? They forced more ridiculous things (e.g. negative balance protection) Or maybe they should force market depth to be available in every front-end application? I am not a fan of regulators messing with trading contracts too much, so I would be in favor of forcing a display of the market depth - more comprehensive information about the service capacity.” 

His opinion was advocated by Chiranjeev Singh Chhabra, founder of Worldfxclub:

"Nice angle to it . I had a survey last year in Dubai where I met clients from different brokers and asked questions about spreads, liquidity & other crazy offers what brokers offer . I found out that there is huge gap in basic fundamental knowledge. Most of them are attracted by the brokers by their crazy offers or bonus. Higher leverage . Swap free accounts . Zero commissions and stuff like that . I think the whole fx brokerage industry is going on path of getting rich quick.

Clients wants or lured to get rich quick . Hence broker offers such offers and brokers or small brokers get lured by the insane b book gains and stuff like that. But I liked ur angle of showing things upfront especially the market depth info.”

Nevertheless, Jan Kotowski, product owner at XTB disagreed. He argued to solve the issue by education:

"Market depth comes with cost, it's usually different between brokerages for virtually every CFD and also different than on underlying instruments.

So the cost of data would be of course transferred onto final customer and the risk of arbitrage trading would be incurred by brokerages, which would need to somehow mitigate it (which comes at cost -> most likely compensated by charging customers extra in this way or the other.)

That wouldn't be a big problem for well established firms, yet it would significantly raise barriers for new business->reduce competiveness in the industry->worsen final customer situation.

Thus I believe the only correct way to solve the issue is by education.

Also I don't believe brokerage business is unethical by nature. Quite the opposite - leading firms like XTB/X Open Hub put significant efforts to ensure not only us but also our business partners maintain highest ethical standards and apply code of good practice to everyday activities.

Other big name companies do the same, thus customers are led towards solutions that can in fact improve their financial situation.

We are no longer in casinos-like business and practice of such service delivery is rather publicly criticized than promoted.”

In the final analysis, forex brokers would not run a business at a loss. Seeking highest possible profit would be a reasonable choice for all of them. As long as the ultra-low spread can attract enough clients, they would find no motivation to change that. Besides, this is only the tip of the iceberg: some FCA-licensed forex brokers place their clients under offshore-licensed companies to avoid regulation or to provide higher leverage to clients; Some internalize trades placed by ECN accounts; Some even manipulate spreads or slippage during less liquid time as small changes are hard to notice.

Regulated forex brokers can ensure normal withdrawal, but they still get myriads complaints about latency and slippage, Are these truly inevitable? Do they keep it as it is intentionally?

Proposal for Information Disclosure

Whether market depth and education work or not, they are aimed at improving transparency across the forex industry so that forex traders’ benefits can be better protected. Just like we compare parameters when purchasing a vehicle, such as acceleration 1-100kph, gasoline consumption per 100km, wheelbase, curb weight, engine displacement, to name a few.

In fact, regulatory bodies have made efforts to improve industry transparency, but the results are not effective as expected. One of the typical cases is RTS 28, where different companies may have different interpretations. Moreover, forex brokers adding crypto assets into offerings will bring more challenges to regulators.

What if forex brokers disclose all information regarding forex trading just like the auto industry? Now, some of the most common available data from forex brokers include:

Trading instruments;

Stop-out limit;

Spread;

Maximum leverage;

Scalping allowed or not;

EA allowed or not;

Minimum deposit;

Swap fee (long/short);

Banking service fee;

License;

Inception;

On top of that, forex brokers should disclose some other data for a certain period of time, such as:

Minimum slippage;

Maximum slippage;

Likelihood of slippage;

Average spreads;

Proportion of trades executed on A book and B book;

Liquidity Providers;

Maximum latency;

Market depth, of course.

The above mentioned data is for instance only. It is a step further from Marcin's idea.

It is easy to make the whole industry transparent, but it may infringe many's interests and benefits. Many forex brokers internalise trades while claiming they have no dealing desk, some may even turn out to be complete scams.

Disobeying rules may generate the largest possible income in a short time, but in the long run it is detrimental to a forex broker, or even the the whole industry. So let’s put ethics aside. If you want make constant income instead of only a bite of the cake, then making your data transparent is the first move to go.