Yesterday I was in Brisbane presenting to a group of forex traders from around Australia, several of whom were my former students a number of years ago and are now trading professionally in a full time capacity. One of the key subjects that I covered in my tutorial was interbank liquidity and price creation, obviously some of the more experienced forex traders in the audience understood what I was talking about but it was astonishing to see that allot of forex traders still do not understand just how currencies are priced. In order to fill in the gaps I have published this brief guide.
As many people that have traded forex previously know, forex isn't traded on an exchange but rather it's traded on an over-the-counter (OTC) basis. Trading over-the-counter is a new notion for those who have traded shares in the past as no two brokers are going to be exactly alike, this really is very different to stock brokers who will always show you the same prices. Among the many other major differences is that because there is no central exchange when trading forex over-the-counter there isn't a physical exchange of any foreign currency but rather you're trading directly with the forex broker, this means that when you open a position with your forex broker you can only close it with that company not like trading stocks where you can sell your shares through any stockbroker.
Now that you comprehend the notion that forex trading is carried out on an over-the-counter basis I will commence by explaining the fundamentals of price creation. As a result of the OTC nature of forex the majority of transactions take place between banks and forex brokers as such they are not reported on a central exchange, it's because of this that price creation in the world of forex is more difficult, however like equities and all markets there are several major players in the forex trading world that make prices move, they are the investment banks. Banks generate prices through their transactions with one another and in many cases they'll quote prices through a system called EBS which permits one bank to see the prices shown by a different bank. EBS however isn't employed by all investment banks, what this means is that there are other investment banks dealing on prices shown outside of EBS, essentially their own market.
So what will this all mean to you? Well this means allot if you are trading using a market maker or STP forex provider who will basically show you a price that they get from one bank or otherwise a price that they derive themselves which is just based on the price that they obtain from the bank they deal with this means you may not always be receiving a fair price. The excellent news is that there is now an alternative, there are some forex brokers that can show you an aggregated price feed from a variety of investment banks and also allow you to take part in the pricing formation, this means that it is possible to place your own bids and offers amongst those offered by some of the world's biggest banks. Forex brokers offering this kind of facility are often called ECN brokers.
ECN providers are hard to come by and operate in an extremely different way to traditional forex brokers. Besides the enhanced pricing offered by ECN fx brokers they'll always charge commission, for many traders this is unheard of however to the shrewd trader this is usually a better way to trade. One of the major advantages to paying a commission over a spread is the fact that you really know just how much you are having to pay your broker, their commission is not hidden in the spread. Paying a commission also means more opportunity, since you're paying the natural market price you are able to get choice and even inverted spreads something you'll never observe using a conventional provider.
Before you all send me a million emails asking which provider I deal with I might as well save space 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 very obvious that if you look hard enough you will be able to find several ECN brokers, just be sure to carry out your homework before you opening an actual trading account as you will find quite a few fx brokers in existence that claim to be ECN providers but are actually market markers. I have trialled practically all the ECN brokers and so-called ECN brokers and found that there is only one true ECN forex provider and this is also the company that I personally trade with, it's Australian based provider IC Markets. IC Markets have the best execution by a long shot and their pricing is one of the most precise that I've ever witnessed. As the majority of you already know I don't endorse any particular broker, I just trade using the forex broker that I feel has the most competitive product and most transparent pricing and that forex broker is IC Markets.
As many people that have traded forex previously know, forex isn't traded on an exchange but rather it's traded on an over-the-counter (OTC) basis. Trading over-the-counter is a new notion for those who have traded shares in the past as no two brokers are going to be exactly alike, this really is very different to stock brokers who will always show you the same prices. Among the many other major differences is that because there is no central exchange when trading forex over-the-counter there isn't a physical exchange of any foreign currency but rather you're trading directly with the forex broker, this means that when you open a position with your forex broker you can only close it with that company not like trading stocks where you can sell your shares through any stockbroker.
Now that you comprehend the notion that forex trading is carried out on an over-the-counter basis I will commence by explaining the fundamentals of price creation. As a result of the OTC nature of forex the majority of transactions take place between banks and forex brokers as such they are not reported on a central exchange, it's because of this that price creation in the world of forex is more difficult, however like equities and all markets there are several major players in the forex trading world that make prices move, they are the investment banks. Banks generate prices through their transactions with one another and in many cases they'll quote prices through a system called EBS which permits one bank to see the prices shown by a different bank. EBS however isn't employed by all investment banks, what this means is that there are other investment banks dealing on prices shown outside of EBS, essentially their own market.
So what will this all mean to you? Well this means allot if you are trading using a market maker or STP forex provider who will basically show you a price that they get from one bank or otherwise a price that they derive themselves which is just based on the price that they obtain from the bank they deal with this means you may not always be receiving a fair price. The excellent news is that there is now an alternative, there are some forex brokers that can show you an aggregated price feed from a variety of investment banks and also allow you to take part in the pricing formation, this means that it is possible to place your own bids and offers amongst those offered by some of the world's biggest banks. Forex brokers offering this kind of facility are often called ECN brokers.
ECN providers are hard to come by and operate in an extremely different way to traditional forex brokers. Besides the enhanced pricing offered by ECN fx brokers they'll always charge commission, for many traders this is unheard of however to the shrewd trader this is usually a better way to trade. One of the major advantages to paying a commission over a spread is the fact that you really know just how much you are having to pay your broker, their commission is not hidden in the spread. Paying a commission also means more opportunity, since you're paying the natural market price you are able to get choice and even inverted spreads something you'll never observe using a conventional provider.
Before you all send me a million emails asking which provider I deal with I might as well save space 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 very obvious that if you look hard enough you will be able to find several ECN brokers, just be sure to carry out your homework before you opening an actual trading account as you will find quite a few fx brokers in existence that claim to be ECN providers but are actually market markers. I have trialled practically all the ECN brokers and so-called ECN brokers and found that there is only one true ECN forex provider and this is also the company that I personally trade with, it's Australian based provider IC Markets. IC Markets have the best execution by a long shot and their pricing is one of the most precise that I've ever witnessed. As the majority of you already know I don't endorse any particular broker, I just trade using the forex broker that I feel has the most competitive product and most transparent pricing and that forex broker is IC Markets.
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