Are market makers betting against clients?
In China's foreign exchange market, most investors believe that market makers are "betting against clients," meaning they take the opposite side of clients' positions. Many forex companies advertise "STP or ECN" trading models to attract customers during their market expansion efforts.
So, what is the operating model of a market maker?
First, it's important to understand the concept of a market maker. A company with market-making qualifications represents a certain level of qualifications and credibility in the market. It's a quality company. Being a market maker indicates that it is a large, financially strong company, which is under strict regulation (for example, ASIC-regulated full-license brokers with trading account qualifications, that is, market-making qualifications), and has sufficient capital to provide liquidity. It has the technology to offer transparent pricing and can provide fair services to clients. This is what a market maker is.
At the same time, it plays another role: maintaining the stability of market prices, which a capable market maker can achieve. Therefore, a real market maker has a positive image.
However, in the eyes of many domestic investors, market makers are viewed negatively, as they are equated with betting platforms. A betting platform does not transfer its own risk; it holds all client orders and stands opposite the clients. When positions are severely unbalanced, betting platforms may manipulate outcomes in the background to achieve profits.
Brokers with market-making qualifications have the capacity to take on clients' positions, which is independent of how clients' trades and the management of the risks associated with those trades occur.
Market makers can scientifically and reasonably transfer their own risks in the market. For example, if a client buys EUR/USD, the broker sells EUR/USD. Market fluctuations are relevant for both the client and the broker after a position is taken. The broker must observe the market; if the market rises, the broker will lose money. If the broker agrees with the client that the Euro is likely to increase, then the broker will hedge that risk by buying EUR/USD. The direction of the broker's hedge is the same as the client's position, not against it. In this scenario, the broker has the ability to transfer risk without affecting the client's trading. Moreover, when the broker enters the market, the volume is significant; it isn't practical or cost-effective to hedge individual retail client positions one by one. Brokers manage a portfolio of risk positions they have passively acquired from clients, encompassing a variety of products and resulting in diverse position combinations, such as gold, oil, bonds, etc. Brokers utilize combinations of positions and market correlations, such as commodity currencies with gold, crude oil, and copper, and the US dollar with the US dollar index, to establish and adjust their risk position portfolios. The volume of the broker's market hedging is large, operating under a principle that client trading should not be affected, adopting procedural or quantitative operations. This approach allows orders to be gradually absorbed in the market without immediate notice, avoiding drastic price fluctuations—this is the duty and obligation of the broker.
When the market experiences major movements, retail investors become particularly excited and trading becomes more active, while the trading volume for brokers decreases. During these active periods, there's no need for brokers to make drastic moves with clients. Brokers have their own judgment and risk management systems, enabling them to scientifically and rationally transfer their own risks. Clients' trading operations and the platform are separate, with a clear firewall in between.
There's only one scenario where clients' orders must be handled directly by the platform: when a client's order volume is exceptionally large, and the broker must find liquidity for them. It's unrealistic for an investor to expect that submitting a 200 million order will result in immediate execution at the desired price. In such cases, the platform needs to communicate with the client that the market lacks liquidity for their order. The broker must then divide the client's order to find liquidity, determining execution prices across different banks and calculating an average price; this process may take some time. Professional investors would understand this process. However, clients in China might not fully grasp it, expecting it to be like playing a game where orders are executed instantly at seen prices. The price at which your order is executed is the price confirmed by the server at the time your order is received, not the price you see at the moment, as the market is constantly changing. Many clients mistakenly believe that they should get the price they see when placing an order. This is incorrect; the process from seeing the price, placing the order, to execution by the server takes time. Currently, there is no technology that can resolve this issue at the retail level without significant cost for advanced technology.
Most brokers in the market are retail Forex CFD brokers, with only a few offering institutional services. Retail order volumes are typically not very large. Brokers claiming to operate under the STP/ECN model and stating that they route every client order to the interbank market are exaggerating. Routing to the interbank or institutional markets involves settlement, and the cost of settling such high-frequency orders of 50,000, 30,000, or 10,000 is too high. No one can realistically accomplish this. Thus, claiming to be STP or ECN is merely about the order processing method and pricing model, not about actually sending client orders to the interbank market.
What is STP? It ensures that clients' orders are processed quickly due to the presence of reliable liquidity providers, like large brokers such as FPG, where orders are fully automated and processed at extremely high speeds. If acting as a counterpart to banks, they would require a substantial margin, which smaller institutions cannot afford due to the required margin payments or unwillingness to pay. They won't find a bank to act as a counterparty and instead turn to large brokers like FPG, which require a lower credit rating than banks and offer more lenient agreements and higher leverage. Many small to medium-sized brokers are thus willing to connect with us.
Therefore, they form an STP with us, where we handle all incoming customer orders, and behind every STP/ECN, there's a dealing room. Of course, not all STP is complete; it's partially STP, and most do not adopt STP.
As for ECN, it is just a pricing model. Don't assume that seeing ECN prices means entering the interbank market—no one does. Only when a broker receives an orders of significant volume, not in the retail concept, and helps route it to the interbank market, is it truly entering. Thus, the ECN pricing model is convenient for those customers wanting lower spreads, but it also involves commissions, as providing ECN pricing certainly costs the broker a substantial amount, which inevitably gets passed on to customers.
We see brokers advertising ECN/STP without issue; you can advertise, but if you claim that all orders go to the interbank market, to names like UBS, Goldman Sachs, that’s misleading—it's impossible.
