Why you shouldn’t touch these brokers

Back in 2018, when new margin requirements came into force in the UK, a lot of traders started looking to overseas brokers.

Suddenly trading in the UK felt more expensive, and they wanted to shop around for cheaper options.

Firms in the Cayman islands or Cyprus, for example, were offering low-margin options, allowing traders to take out high-leverage positions with just a small amount of capital in the account.

Overseas brokers are often functioning under less regulation, and you won’t get the protection of the financial services compensation scheme, so if your broker goes under, you’ll have no recourse. But that’s just a fraction of the problems you can run into …

What are the real costs of trading in a less regulated environment …?

What I want from my broker

We often moan about regulation tying us up and restricting our freedoms, but usually each piece of regulation has been hard-fought-for by people who are fed up with being ripped off.

Just this morning, Barclay’s boss Jes Staley told the BBC, “I wouldn’t burn one piece of regulation.” In fact, he said the UK’s robust regulation was a major strength, not weakness.

Earlier this week, the price on one of my open trades came within a fraction of a point of my stop level, then turned around without touching me out.

I know that it can often feel like our trades are getting touched out, but a lot of that is to do with the crowded areas we tend to position stop levels. So it’s important to recognise the times they DON’T get touched out.

Don’t take this for granted – it is the direct result of trading in a highly regulated market.

How brokers make money

Spread-bet firms (as their names suggest) make money on the ‘spread’ – the difference between the buy and sell prices on your trades. This gives them a cut, every time you place a trade, whether it wins or loses.

While I don’t enjoy paying a spread – it’s a transparent cost that’s agreed up-front on the trade.

To a large degree, your broker’s book will be naturally balanced, with one client selling GBPUSD, and another buying GBPUSD. As one side wins, the other loses, and the broker is taking no risk in the market, instead just earning money from the spread and daily rolling charges their clients pay.

For the proportion of their book that isn’t balanced, a broker will have risk limits they must work within, and will look to lay some of that excess risk off in the real market – going out and buying GBP (or whatever) to balance their book.

So, for the most part, your broker is just a middleman, remaining market neutral and taking his cut. But with any unhedged positions on their books, they will be taking a risk, and are essentially betting against you.

Not all brokers work this way

The prices offered by your broker are not necessarily the true market price, but can vary by a few points. This does give them the opportunity to manipulate the prices you see on their platform, so they could nudge prices to take your stops out.

But if you’re using an FCA regulated broker in the UK, they’d be breaking the law doing this. Also (unless they were manipulating prices to an individual client level) they’d be leaving themselves exposed to others getting into a market at a false and advantageous price – so it’s a very dangerous game for them to play.

Established UK-regulated brokers are being driven towards a business model based on making money on their spread and rolling charges and wanting to retain clients so they’ll keep that business coming in.

That’s not the case everywhere.

In less-regulated markets, it’s very possible for brokers to have a business model which is to NOT hedge their books and to directly make money as their clients lose it. They will draw in new clients with offers of cheap costs, and burn through those clients as they wipe them out. There are plenty of horror stories out there of Ponzi-type schemes where brokers are directly working against clients.

Of course, not all overseas brokers will be like this. But with a lack of pricing transparency and little regulation, it’s far too easily done.

Trading is tough enough without having to battle your broker working against you!

Before you scream at me that I’m being naïve about the intentions of my UK broker …  I’m no stranger to getting my trades just touched out at their stop … or just missing a profit target by a fraction of a pip. And I expect I’ve cursed my brokers’ pricing as much as the next trader … But I’m also aware of the benefits of regulation.

All the bargain spread costs and low margin requirements in the world don’t make up for having some confidence in the pricing that your broker is applying. Faith in your broker is the most valuable trading tool you can have. So, while I have plenty of specific grumbles about the FCA, I’m very grateful to be trading in a heavily regulated market and wouldn’t put my money elsewhere.

 

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