How SB firms manage their counter party risk? and few more questions

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alexft

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Hey folks,

I found this article Do IG Index Hedge or NOT?

Also I read in IG TOS -
we may make a market in Bets which you enter into under this Agreement

we may deal in the Underlying Market to which your Bets relate as principal for own account or that someone else
Click to expand...

Make market is Bets means match customers bets or something else?

Also say if SB receive a number of really large short orders and they happen to long about same amount in underlying market can they legally bet against their customers combined bets via underlying market and then change prices as market maker and pocket money?

The market maker prices can MM make any price he likes and change it anyway it likes or there are some regulations about it? :D
 
I personally don't know, however I take the view that as long as their prices accurately tracks the underlying and you can trade with limited slippage,
there is nothing to worry about.
And if the firm itself is financially healthy, there is nothing to worry about.
In the light of the failure of a few over the last year, this is of prime importance.
Of course the problem is....How can you determine the firms financial health?
 
alexft said:
Hey folks,

I found this article Do IG Index Hedge or NOT?

Also I read in IG TOS -

Make market is Bets means match customers bets or something else?

Also say if SB receive a number of really large short orders and they happen to long about same amount in underlying market can they legally bet against their customers combined bets via underlying market and then change prices as market maker and pocket money?

The market maker prices can MM make any price he likes and change it anyway it likes or there are some regulations about it? :D
Click to expand...

Whether they hedge everything or anything should be of no concern to clients. We just need justifiable prices based on the underlying market, consistent execution, with no delays and rejections caused by SB's 'reading ahead'.
 
It should really be of concern how the broker/bookmaker handles their exposure. Primarily because it can highlight likely strengths and weaknesses of a firm.

For example, tight spreads. The tighter the spread on offer the lower the flow revenue from the book. Ergo, this would suggest a greater reliance on positional income.

Flow revenue is very important. It is safe income, predictable and ebbs with vols in a crude way. Positional or book income is much more wild. Especially as there are different ways to manage your exposure. The two main ways are to either try and second guess the clients and play in essence against them and the other way is to take no interest in the client activity and focus on the overall exposure and how much is run or hedged given the conditions.

There is also the consideration of how to hedge your exposure. This is crucial for maximising flow income. If you end up paying more to hedge a position than you earn in spread/comm then you aren't very smart. One for one hedging is only smart for singular oversized or toxic trades as it removes market risk and just leaves counterparty risk (often actually worse). Smart hedging of general flow and exposure isn't a 1 for 1 game. It's about understanding the correlations between markets and asset classes. It's about looking at your exposures and knowing what can logically be hedged against what.

That requires skill and experience which costs money. It costs money on people but also the technology. To be efficient at hedging to enable you to hedge the most in the cheapest and least balance sheet intensive way possible you need to know exactly what your exposures are in every market at every second.

The long and the short of it is that the greater your flow the smarter and cheaper your hedging is. But you need money to hedge. Money to pay the right people to run the book, money to build and maintain the systems and money to lodge as collateral at the clearers.

A firm which hasn't got the right people, doesn't have the right tech and doesn't have a large enough balance sheet will be economically steered into the last place a firm without enough money should be, running unhedged. It's a game of whether you can make enough money from pure client losses to build your balance sheet before either you find your book on the wrong side and your clients get it all right and wipe you out or a singular client default event achieves the same.

There are modest ways to relieve pressure from your balance sheet. Not offering equities is the easiest. These are very capital intensive as traders hold positions not job in and out and you need to hedge anything that is not a major index constituent. By not offering or by reducing your equity offering you free up your balance sheet.

In addition, focussing on fx helps. It's 24 hours for hedging and tight margins mean you can run enormous positional exposure with very small capital requirements.
 
Morris 2001....That is a very comprehensive answer for sure.
How would the retail punter find out anything about the broker that means anything to him. The broker just says what sounds good to the customer.
All the punter has is the quality of the service given him.
 
MORRIS2001 said:
It should really be of concern how the broker/bookmaker handles their exposure. Primarily because it can highlight likely strengths and weaknesses of a firm.

For example, tight spreads. The tighter the spread on offer the lower the flow revenue from the book. Ergo, this would suggest a greater reliance on positional income.

Flow revenue is very important. It is safe income, predictable and ebbs with vols in a crude way. Positional or book income is much more wild. Especially as there are different ways to manage your exposure. The two main ways are to either try and second guess the clients and play in essence against them and the other way is to take no interest in the client activity and focus on the overall exposure and how much is run or hedged given the conditions.

There is also the consideration of how to hedge your exposure. This is crucial for maximising flow income. If you end up paying more to hedge a position than you earn in spread/comm then you aren't very smart. One for one hedging is only smart for singular oversized or toxic trades as it removes market risk and just leaves counterparty risk (often actually worse). Smart hedging of general flow and exposure isn't a 1 for 1 game. It's about understanding the correlations between markets and asset classes. It's about looking at your exposures and knowing what can logically be hedged against what.

That requires skill and experience which costs money. It costs money on people but also the technology. To be efficient at hedging to enable you to hedge the most in the cheapest and least balance sheet intensive way possible you need to know exactly what your exposures are in every market at every second.

The long and the short of it is that the greater your flow the smarter and cheaper your hedging is. But you need money to hedge. Money to pay the right people to run the book, money to build and maintain the systems and money to lodge as collateral at the clearers.

A firm which hasn't got the right people, doesn't have the right tech and doesn't have a large enough balance sheet will be economically steered into the last place a firm without enough money should be, running unhedged. It's a game of whether you can make enough money from pure client losses to build your balance sheet before either you find your book on the wrong side and your clients get it all right and wipe you out or a singular client default event achieves the same.

There are modest ways to relieve pressure from your balance sheet. Not offering equities is the easiest. These are very capital intensive as traders hold positions not job in and out and you need to hedge anything that is not a major index constituent. By not offering or by reducing your equity offering you free up your balance sheet.

In addition, focussing on fx helps. It's 24 hours for hedging and tight margins mean you can run enormous positional exposure with very small capital requirements.
Click to expand...

Do you need to know how an engine works to drive a car, or be a vet before you can buy a bottle of milk?
 
alexft said:
The market maker prices can MM make any price he likes and change it anyway it likes or there are some regulations about it? :D
Click to expand...

In my opinion (just in my opinion - howling is not necessary for those inclined to it) if one wishes to trade for a living, sooner or later one will need to use a broker that is incapable of profiting when one loses.

From my (quite extensive) observations, when I used IG for products traded on a regulated exchange - so a proper comparison was possible - their prices and charts were very good. Not exact, but extremely close, so I should point that out in the interests of fairness. Slippage was rare and it went both ways.

However, they'd add 3 ticks to the spread for the mini dow and nasdaq and 1 tick to the spread for the mini s&p, so the cost really becomes prohibitive.

For non-exchange products, who is to say what the price actually is? What is the "official" rate for EURUSD? And as for their cash indices, have a look and see if you can find out how they are calculated.

Someone was talking recently about trading the some bucketshop's cash DAX. He compared the price with the cash DAX from another bucketshop - apparently they were about 20 points apart for over an hour.
 
MoonRocket said:
Morris 2001....That is a very comprehensive answer for sure.
How would the retail punter find out anything about the broker that means anything to him. The broker just says what sounds good to the customer.
All the punter has is the quality of the service given him.
Click to expand...

That is a good question and it's very difficult to answer.

From the inside it is relatively easy to know who has a well run book, who is applying slippage fairly, who has a balanced spread of clients and who has a good balance sheet and which clearers are used for hedging.

From the client perspective it is very difficult but not impossible to get a relatively honest impression.

How would you start? This is difficult :). From a personal perspective I would look at the range of markets and their margins and spreads.

Firms have to make a trade off between controlling risk and using spread and margins to market their services.

History has shown us time and again in many financial fields that cheapest is very rarely the best. Weaker firms tend to have to undercut heavily to obtain clients.

Margins on equities and the range of equities can be quite telling. You can for example look at the illiquid small stocks and if margins undercut the average then it might indicate a lack of hedging as the client margin may well be lower than the clearers margin. Not hedging small caps would be a concern.

FX spreads are more difficult because with no centralised market the broker can offer what they like. And even if they publish tiny spreads you can still average a couple of pips using slippage. Also if a broker doesn't widen their fx spreads during volatile events and will still fill client orders this would have indications over hedging policy as the clearing banks the quotes are amalgated from will definitely have widened theirs or pulled them altogether.

Pushing clients to elect up their FSA catagory would be a concern. Offering zero spreads would be also.

Other important facts would be the transparency of who the owners were and where they are based.

Unfortunately it would be next to impossible for a client to know the spread of other clients but I am always wary of firms which run cosy hospitality events for big clients. Big clients are a default risk, tend to make staff focus on them and not the average client etc etc.

I'm not sure if these thoughts are much help but I hope so.
 
MORRIS2001 said:
Hi. Sorry but I'm not understanding the analogy in this instance.
Click to expand...

IMO trading is all about finding a way of making a consistent profit and managing your own risk, not worrying about how the broker or SB provider makes money. The important thing is that platform works reliably and fairly.
 
I tend to agree but certainly how your broker processes and handles your positions will have a heavy impact on risk and performance.

Re-quotes are an example here. A broker may requote heavily as they are wanting to match their amalgamated FX feeds for hedging (a clue is sometimes when their quotes widen rather than remain fixed) or that they may be focussing less on overall flow and more on individual account activity, the latter not really being good for the client unless they are regular losers.

Whether a broker has their own tech can have an impact. Few have the capital to build and maintain platforms and sometimes this is due to owners not reinvesting money but taking it out.

In addition the larger the flow a broker has the more stable their prices as they rely less on skewing in order to balance their exposure.

I agree completely that fair quotes and a reliable route to market are core, it's just that often what gives you these parameters is based on how the firm is structured and run.

Cheap spreads are rarely an indicator of a superior broker, likewise with low margins. They can be indicators that suggest looking deeper into how they look after your money.

Over the last few years we've seen GT247, ProSpreads, Echelon, MFG and WSpreads go and there are similarities amongst them all even though there were varying direct reasons behind each failure. But you can also see firms still out there being run the same way.

It's important for a trader to manage their risk as a priority but they cannot also manage their broker's risk so it is worth learning as much as possible about how they function so as to best try to mitigate slippage, requotes, misquotes, 3rd party or primary tech issues and at worst default.
 
Morris2001....Thanks for your considered answers. I think what you have said helps a lot in choosing a broker.
Personally, it makes me satisfied with my decision to switch from CMC to GFT.
I had a independent forex data supply, mainly to check the prices I was getting from the brokers.
GFTs spread stayed exactly evenly distant from the traded price. Also when the spread widened it would so do evenly.
I haven't seen any induced volatility as was the case with CMC, who would induce volatility milliseconds before a big move.
 
Last edited:
MoonRocket said:
Morris2001....Thanks for your considered answers. I think what you have said helps a lot in choosing a broker.
Personally, it makes me satisfied with my decision to switch from CMC to GFT.
I had a independent forex data supply, mainly to check the prices I was getting from the brokers.
GFTs spread stayed exactly evenly distant from the traded price. Also when the spread widened it would so do evenly.
I haven't seen any induced volatility as was the case with CMC, who would induce volatility milliseconds before a big move.
Click to expand...

FX is such a difficult product to deliver to retail customers as there are so many different ways to deliver your price and it's allways open to misunderstanding or miss use.

The lack of transparency due to no central exchange and the history of being unregulated means there are very unscrupulous people in the market.

The real issue a good broker has is which clearing firms to take quotes from, how to amalgamate the data and crucially how react to liquidity squeezes. The latter being the events which can and will upset your clients.

When there is a liquidity contraction the clearers will widen their spreads and also potentially pull their quote from unflavoured clients.

So, a firm may have 3 or 4 clearers supplying quotes but if they are small or don't hedge much then one of their clearers may pull their quote and leave the firm with wide hedging costs and the dilemma of like the clearers not wanting to increase exposure at that time but needing to deliver a quote to their customers. Some will widen to match the clearer so deals can be done, some will maintain spreads but effectively not accept orders and others will run it on their book. In reality it is usually a blend of the various options.

But, crudely speaking, a firm which delivers good volumes to a selection of clearers will have an advantage over the quality of service they can extend to their clients at the exact time lots of clients want to deal.

Understanding what liquidity sources a broker has access to can be important information. Obviously this is confidential information but the way a firm acts over liquidity squeezes can give some relevant information.
 
MORRIS2001 said:
Over the last few years we've seen GT247, ProSpreads, Echelon, MFG and WSpreads go and there are similarities amongst them all even though there were varying direct reasons behind each failure. But you can also see firms still out there being run the same way.
Click to expand...

ProSpreads is still trading - it hasn't failed.
 
Hey Morris

some interesting points - T2W need to let you run a section here all by yourself........;)

I am amazed at how wannabee Traders chase the lowest spread Brokers (or blindly take the recommendations from their Mentors/trainers) and dont care a fig about the inherrent Risk factor chosing these Brokers

Personally i'd rather lose a few pips per trade than never get the money back ;)

N
 
I dont blame the Brokers .....they are just chancing and trying to make a living........if they get a licence then its game on

its the responsibility of the Trader if their money dissapears down the pipe...

Everything in Trading is the personal Traders responsibility - like any business you own and run.......wear it

if people dont want to take this responsibility - work for someone else and delegate all the rewards and responsibility that way :p

N
 
Thanks.

The reality is that there are some really well run and respectable firms in this industry and some absolute shockers. From the inside you tend to know who the shockers are as the same names keep cropping up in the background. Once someone has learnt how to spank the bejesus out of a client base they don't usually give up just because the firm ceases to exist.

I am staggered sometimes when I see comments from people considering putting their hard earned money with some firms.

But the signs do tend to be there if people wish to look hard enough and protect what they have worked for.
 
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