Let’s take a look at a couple of other examples of how A-Book brokers make money.
Let’s see what happens if EUR/USD falls instead and Elsa ends up with a losing trade.
In this example, Elsa opens a long EUR/USD position at 1.2001.
Her position size is 3,000,000 units or 30 standard lots. This means a 1-pip move equals $300.
EUR/USD falls hard.
Elsa decides to cut her losses and exits at 1.699, ending up with a loss of 302 pips or $90,600 ($300 x 302 pips).
Since the broker is her counterparty, this means that the broker ended up with an equivalent gain.
But…the broker was also in a separate trade with an LP.
In this trade, the broker ended up with a loss of 300 pips, which means its counterparty, the LP, ended up with a gain of 300 pips.
The profit made from its trade with Elsa exceeds the loss incurred from its trade with the LP, so the broker still made an overall net profit of 2 pips or $600 ($300 x 2 pips).
Notice how the broker’s P&L ended up being the same regardless of whether EUR/USD went up or down.
Because the broker had transferred the market risk to the LP, it missed out on the 302 pips it would’ve gained if it had just internalized the risk.
But that’s the tradeoff for hedging.
When a trade is “A-Booked”, the advantage to a broker is that it’s no longer exposed to potential LOSSES due to price movements, but the disadvantage is that it’s also no longer exposed to potential GAINS due to price movements.
The broker’s revenue comes strictly from price markups.
As you’ve just learned, since an A-Book broker is not taking any risk on the trade, they make money by “marking up” the spread or charging a commission.
This business model removes any potential conflicts of interest since the broker would earn the same amount of money regardless of whether its customers win or lose.
The broker makes money regardless of how the market moves.
Of course, this all assumes that the A-Book broker has the backend technology to act quickly and without errors when hedging customer orders.
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