When a Consumer makes profit, does this mean the broker loses capital?

Do brokers have to shell out profits to sucessful retail consumers in the Forex Market?

It depends on the broker.

For example, if you trade on LMAX, you do not "against" the broker, but directly with other people or institutions, for example with banks or Hedge funds.

However there are other Brokers, which of course I don't name for fairness reasons, which trade directly "with" or "against" the client. So your profit is their loss and vice versa. They basically say "Hey customer, I'm gonna bet that you lose money" which is actually true in most cases since only few traders are profitable on the long run. So this concept can be really lucrative for a broker since most people lose money in the forex market.

normally no

usually what happens is for example, if you buy EURUSD

- your broker sells it to you with a spread of few pips
- then he 'goes to the bank' (all automated of course) and buys it with much smaller spread

so now if EURUSD goes up or goes down the broker doesn't risk either winning or losing and only makes money on the difference only in spread between what they sold to you and what they paid to the bank

some few shady brokers want to gamble. they think most newbs lose money, so why not just skip the 'going to the bank' - (hedge the risk) and let you keep the EURUSD which you bought and if it goes up and you decide to sell it back to them when it's more expensive they will have to buy it from you and lose money. so this is the way they would trade against you.

so if you make a profit and the broker hedged it - in this way its the bank who shells out your profit. but of course the bank also probably bought from some other trader who was dealing with some other broker on the other side. or the bank had a bunch of EURUSD in inventory which they bought even cheaper than you did before you did, so they didn't lose that much.. all in all its mostly traders trading with traders and the brokers and the banks taking spreads of various sizes either immediately or through time by holding huge inventories which they bought at many different prices (they have a lot of money).

so really in a roundabout way its always other traders losses that shell out for your profit.

also sometimes your trade is just not big enough to be worth for the broker to hedge it

and of course the broker doesnt hedge every single trader's trade individually but just adds up all the traders who buy EURUSD right now and the traders who sell EURUSD right now and just hedges the leftover difference, if there is any difference. this way this brokers' customers are mostly just trading with each other and the broker just takes as much of the spread as possible

I think that applies to MM or Market Makers right? I don't know much about MM

This may be common with NDD (no-dealing-desk) brokers, a.k.a. market maker brokers. But now there are other options such as STP and ECN brokers that require no intervention from the broker - the client is dealing on the true fx market. These may be better options.

The 'true fx market'?

I can't think of one broker who isn't counterparty to clients trades, they have to be as the trading agreement/contract is between client and broker and not with any other party. Thereby a potential conflict of interest always exists.

Yes a conflict of interest does exist though that does not mean that every broker is out betting against you.

Which is why I said potential conflict of interest.

They're counterparty and it's anyone's guess what they do with an order once they've filled it, presumably they hedge nett exposure above some sort of predefined risk parameters but we don't know that. We also don't know how/where they derive their streaming quotes, nor if they shade price, widen spreads, create artificial spikes etc etc etc......it's all well within their capabilities, probably extremely lucrative, and what's more perfectly legal!

The best we can hope for is they play fair and that we make some money, or if we're that worried we can always go trade another market!

Brokers are a means to an end, none are ideal but that's the price we pay for smoothed quotes, instant fills, and tight spreads. Without them most of us wouldn't be able to trade this market.

What about the Futures market where the market is centralised? I suppose the same applies as you still have to trade via a broker rather than doing a direct deal with the opposing party.

I know of at least one broker whose level 2 market depth displays quotes from 4 liquidity providers (all major banks / brokers) - the client can choose which one to trade with - the deal is done and, of course, the broker then steps into the transaction as the counterparty - but the client chose whom to place the deal with and at what rate. The broker is paid for his services through the commission, not the pip spread.

And the name of that broker is.....?

It's mostly a marketing exercise, the contract small print is usually the same regardless of what they tell you in the hype.

Futures has it's own set of problems, I prefer spot through a bucketshop to be honest, they fill pretty much everything you throw at them. Sure they've got their drawbacks but that's just the price of doing business, the benefits outweigh the negatives for me!

Still learning the ropes where the futures are concerned and it is really tough. For one, liquidity is not the same as the Fx spot market. And on the whole counter-party and Fx brokers, wasn't the recent legislation aimed at making the process more transparent and leverage reduced to protect customer interest?
Either way, you would think the brokers would list out where they get the quotes from..but that's me and a zillion other traders going *sigh*