Let’s discuss more on how do forex brokers work.
Unlike Batman in the story in yesterday’s post, you’re not going to know who you are trading with. And even if you did, that doesn’t mean you should blindly trust them.
Even Batman was duped by a fellow superhero, who was supposedly a “good guy”.
Your forex broker is a faceless corporate entity that requires you to send it money so you can open trades with it.
Are you sure they are who say they are? Is it a legitimate company that really provides forex trading services?
Or is it a fake forex broker? How do you know the company won’t just take your money and disappear?
Who are you really trading with? Is it a reputable broker?
Notice how Spider-Man or Batman didn’t actually own any British pounds. No actual pounds were ever exchanged. They were simply making dollar-denominated bets on the price fluctuations of GBP/USD.
So if you’re not actually buying or selling, what are you trading?
Notice how Spider-Man created a “market” (to bet on the price direction of GBP/USD) for Batman with just his imagination?
Did you also notice how there were only two parties involved?
Whenever Batman made a bet, Spider-Man did not go out into the “market” and search for another person to take the opposite side of the bet.
Spider-Man simply took the opposite side of ALL of Batman’s bets.
As long as both agreed on the terms, real bets were made and were expected to be honored. Nobody else was involved.
So if you’re not trading in the “market”, where are you trading?
During the last bet made between Spider-Man and Batman, notice how the price of GBP/USD moved unfavorably against Spider-Man and he ended up not having the money to pay?
Because Spider-Man is the sole person taking the opposite side of Batman’s bet, Batman should’ve made sure that Spider-Man would be good for the money.
The same concern should be made with retail forex brokers since they operate in a similar fashion.
So if your forex broker is always taking the opposite side of your trades, how does it avoid the risk of going bust? And taking your money down with it?
Notice how Spider-Man can quote any price he wants?
Fortunately, Batman was smart enough to use his Batphone and reference a third-party data source (Google) to verify if the price that Spider-Man was using was accurate.
But what if he didn’t? Once the bet was made, Spider-Man could continue to make up prices in his favor. For example, he could say that GBP/USD has fallen 500 pips (even though it hasn’t), and Batman would be forced to bet at a loss.
So if your forex broker is able to quote you any price it wants, how do you know the prices see you on the trading platform are fair? Where do the prices come from?
Notice how Batman wanted to open a bet when the starting price of GBP/USD was at 1.4100, but Spider-Man declined and changed the price to 1.4150 instead?
This is known as slippage.
Slippage is the difference between the expected price of a trade and the price at which the trade is actually executed.
Slippage can occur for a number of different reasons and can work for and against a trader.
In Batman’s case, he experienced negative slippage, which is where Spider-Man gave him a worse price than expected. This results in a smaller profit or a larger loss.
Being quoted a specific price, even if it’s accurate and fair, means NOTHING if your order can’t execute at said price.
How can you determine the quality of its order execution? Where orders will be executed at your requested prices?
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