Specifically, you seek to profit from fluctuations in the exchange rates between currencies.
You are betting on whether one currency’s value, like the Japanese yen, will go up or down in relation to another, such as the Australian dollar.
Currencies trigger price movements in the forex market either strengthening (price appreciation) or weakening (price depreciation).
They limited your ability to open AND close trades to the prices that your forex broker offers to you, as there is no other market for these trades.
So now the question is…
How do you know the prices that YOU see on your broker’s trading platform are an accurate reflection of what’s happening in the “real”(institutional) forex market?
Batman and Robin
Let’s review one part of the earlier story between Batman and Spiderman:
The game works like this: Try to guess if the GBP/USD exchange rate will go up or down.
Let’s say the current exchange rate is 1.4000. Do you think it will go up or down?
Notice how Spider-Man just seemed to make up a price for GBP/USD?
Fortunately, Batman didn’t just take Spider-Man’s word for it and used his Batphone to verify the price with a third-party source.
If you’re not familiar with the story above, this means you haven’t read our earlier lesson on How Forex Brokers (Kinda) Work. It’s highly recommended that you read this lesson first.
Like Batman, you should wonder about the same thing regarding forex brokers.
Are Forex Broker Prices Accurate?
Where do the forex broker’s prices come from? Are the prices accurate?
For any currency pair, your forex broker will quote you two prices:
- A higher price (“ASK”) at which you can buy (“go long”)
- A lower price (“BID”) at which you can sell (“go short”)
Collectively, the ASK and BID prices are referred to as the forex broker’s “price” to you.
The difference between the lower and the higher price is known as the spread.
You see these quotes on your trading platform (or “customer terminal”).
We know these quotes are displayed as a “price stream”.
Where do Broker Prices Come From?
But where do the prices come from?
Does the forex broker just make them up?
But highly unlikely.
Now you might think, “Huh? It’s possible?” but…
Did you know your forex broker may show ANY prices it wishes?
As we covered in a previous lesson about the FX market, retail traders can’t trade in the institutional or “interbank” FX market.
We’re deemed un-creditworthy (“too poor”).
So if you want to speculate on currency exchange rates, you need to find a retail forex broker.
The forex broker “makes a forex market” for you to trade in.
This is either as CFDs (if you’re outside the U.S.) or rolling spot FX contracts (if you’re in the U.S.).
Which together, can simply be called retail “FX contracts“.
These contracts involve only two parties: you and the forex broker.
And since the forex broker creates these contracts, it can technically quote whatever bid and ask prices it wants.
And it’s up to you to choose whether you’ll trade at those prices.
How and where a forex broker sources its prices is totally up to its discretion.
On its trading platform, it may show you prices derived from outside sources or it may not.
This means that prices offered by your forex broker may or may not reflect prices available elsewhere, such as from another forex broker.
Why is this the case?
Shouldn’t the prices quoted by the forex broker be identical to the prices in the underlying (institutional) FX market?
And there lies the problem.
In the FX market, for each currency pair, there is no such thing as one “market price”.
The FX market is what’s called an “over-the-counter” or OTC market.
In an OTC market, there is no centralized “place” where all market participants gather and can see the same SINGLE market price.