CME/Reuters Update: A Wolf in Sheep’s Clothing?

When the Chicago Mercantile Exchange (CME) and Reuters announced they were putting their heads together to provide a standardized, anonymous and transparent Forex trading platform, I was excited by the prospect because, at least conceptually, such a platform would eliminate a lot of the game playing that goes on at the broker level. I was somewhat taken aback, therefore, when I came across the following information on regarding Globex, the CME’s electronic trading system. It’s an eye opener.

Watching a Globex Forex Feed during off peak times where the market-maker is almost the only participant, continuously populating both sides of the queue with tease-orders. Being mesmerised how the market-maker is able to move out of the way of an incoming order execution.

A trading platform is a software process with data inputs and outputs. A "box" with data inputs entering on the left and data outputs exiting on the right. The processes are performed inside the box, based on the requirements of the incoming data stream (orders)

Example: Incoming order - sell 20 lots at market
Status of market depth bid queue prior to order transmission.

Before............................................1 Second After

Market Maker 10 @ 5006....................Market Maker 10 @ 4990
Market Maker 10 @ 5005....................Market Maker 10 @ 4988
Natural Buyer 20 @ 5002.................Market Maker 10 @ 4995
Market Maker 10 @ 5000

The market maker miraculously disappears in nano-seconds. The trade is executed at 5002.

Such behavior is clear evidence the market-maker has access to the incoming order stream, and is able to remove the front orders, allowing the natural buyer to be hit. It's a question of the location of the market. During market hours, exchange and market-maker are separated. During non-pit hours they merge. Market-Making is electronic. The market-maker not only operates the market, they are the market.

If you decide to hit a market-maker sitting in the market, there is nothing to guarantee the order will be there when your transaction arrives. The market-maker can see your order coming. It can simply move out of the way and not be there when your order arrives. If your order is an "at market" order you will be dismayed at the result. You will hit the nearest natural buyer/seller

Ask the question - what question? “What happens when a "participating broker", who is a market-maker, also owns the market (exchange) [which is the case, of course, with every dealing desk broker]?.”

It’s apparent that with CME’s current trading platform, what you see isn’t necessarily what you get which makes me wonder if we aren’t going to see exactly the same thing when the joint CME/Reuter’s trading platform hits the street. Perhaps their unwillingness to commit to allow FCMs to offer the platform is a blessing in disguise.

To see the original posting and more, visit Camron.com.

Recommended Additional Reading

Think You've Been Trading the Forex? Think Again

Advantages and Disadvantages of Non-Dealing Desk Trading

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Confessions of a Marketmaker (Dealing Desk Broker)

Pupkinus, a member of The NDD Forum, sure is making my work a lot easier. He posted a commentary today about a post by an Australian dealing desk broker who gave Forexfactory members a look into the inner workings of the brokerage community. It's a real eye-opener and well worth republishing.

Broker: We also were a marketmaker with our clients. In fact most major Investment Banks are. Contrary, to people's beliefs that banks are straight through processing, which they are - but also dealt clients prices and matched them with other clients.

We would take positions against our clients, quite frequently - as our division was not only a broker to our clients, but a trading house too. You don't understand the amount of losing volume that came from clients everyday.....millions!

Pupkinus:If someone believes that the "Big Cool Reputable Banks" are STPs and will not deal against its clients this post helps put a label of "myth busted" on this belief.

Broker: Although we were a large investment bank, we hated scalpers and often tried to deter them from using us. This is probably why brokers like FXCM place scalpers on manual execution - because scalpers would take arbitrage opportunities from the real marketplace and play them against the price the broker is giving them.

Pupkinus: Now that's a direct hit. People from the inside KNOW that traders are discriminated against (placed on manual execution) because of their trading style.

Broker: The foreign exchange market is not regulated to an extent - but if pricing can not be confirmed as being executed at market prices for that time (market prices means that there must be a record of prices from anywhere in the world being at that quote at that time), it cannot be done, legally.

Pupkinus: Cannot be done legally in Australia. So, maybe a grassroots campaign for CFTC to enforce similar rules on FCM's may help clean the industry?

Personal Observation: I don't think the CFTC has been empowered to deal with this. Any initiative addressing this issue in the United States will have to come from Congress.

Broker: To the idea of chasing stops - yes, this did occur, quite often. During news times mostly. We would see where stops were with our clients, we also had a good idea where market depth was, and we would send through volumes of trades to take them out, in order to make money for the bank.

Pupkinus: Explicit confession of a stop phisher. They hunted for stops the knew were there. Immoral to say the least.

Personal Observation: Seems to me this is a pretty strong indicaton that one should stay away from news trading because stop hunting can be easily obscured.

Broker: If you are a good trader - and know the ins and outs of the market (not placing in house stop losses. etc), you will not need to worry, cause you can play the game - then your sweet!

Pupkinus: Placing stops inhouse = sure way to get in trouble. We have confirmation "from the source".

Broker: For everyone who deals with American brokers go to CFTC - and then go to 'financial reports for FCM's'. Here you can check out the Capital of all the brokerage houses, try to stick to the retail brokerage houses with the highest amount of capital - cause this ultimately means more clients, a better relationship with more banks in the interbank market, cause they can guarantee volumes, and also a better level of service.

Pupkinus: Most brokers have capitalization under $1 mio. A major market move can wipe them out. But capitalization is just one of the traits of a good broker.

Personal Observation: I don't agree with Pupkinus on this one. What value is there to quick executions and oodles of liquidity when the broker acknowledges that they rip traders off to the tune of millions a day? A dealing desk is still a dealing desk and it doesn't matter how much money they have in the bank.

Broker: Brokers aren't bad, they aren't there to be against you. But they may not, in terms of cooperation in the market itself, work with you. Most brokers who are large and service respectible numbers of clients will tend to try to help their clients become profitbale as much as they can but once your order is placed, its every man for [himself]...

Pupkinus: That's the best expression of the conflict of interest that plagues even the well intended brokers. Even if they want to play nice it will always be "but once your order is placed, its every man for himself..." - that describes the very biased nature of the dealing desk business.

Those wishing to learn more about non-dealing desk trading are invited to visit the forum and join in the discussion.

Thank you, Pupkinus.

Recommended Additional Reading

Think You've Been Trading the Forex? Think Again

Advantages and Disadvantages of Non-Dealing Desk Trading

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