So... it turns out that Market Maker models aren't that bad

According to FXCM's statement "clients experienced significant losses, generated negative equity balances owed to FXCM of approximately $225 million."

I'm taking that to mean that 225mio are negative client balances owed to FXCM (i.e. margin calls that clients are incapable of meeting), hence the FXCM's shortfall.

100% agreed. I'd like to think of it this way as well: Since EURCHF went south, the MM brokers came out with their asses smelling like roses. But if the rate had actually gone north at the same speed and intensity, those very same MM brokers might have been regarded as Ponzi schemes of the worst kind.

I think bro Skenobi made a point.

The ultimate cause is leveraging. If leveraging are avoided, most likely these wont happen. And these brokers will not risk traders from incurring losses on them due to their individual losses.

Yes but if fxcm owes that money to their liquidity provider on behalf of their clients.

if there clients say they are bankrupt, and unable to pay, which I'm sure many will, then fxcm has to eat the loss themselves.

That is what iam saying

correct?

I STILL think ECNs are better than an average MM because MM can go bust at any time their winning traders win more than what losers have lost & they can play tricks too but ECNs are at risk during rare events like the one we've witnessed. As I've said, probably the best option for traders are MMs who are good at recongnizing good traders & passing their trades to LPs while keeping the trades of losing traders. Or may be the best option would be ECNs who are very vigilant about managing their risk under exceptional circumstances like the other, be it by reducing leverage for high-risk pairs or by buying some sort of insurance to safeguard the clients' funds in the event of unforeseen circumstances.

Unlike most traders, I've never really had any issues with MM model but it's the honesty that I care about. So if a MM is taking the opposite side of losing traders then & making money out of it then that's fine with me so as long they aren't actually playing tricks like widening spreads to hit SLs, not honoring people's TP, delaying withdrawals, commingling clients' funds, etc but it's just that it's not always easy to sort out the good & bad MMs.

I'm not sure if it going north in a big way would have made a difference. MMs are at risk whenever their winning traders win more money than the money they'll be receiving from their losing traders, it's independent of where the market moves while ECNs are at risk any time there are exceptional moves in the markets with a lot of traders ending up with a negative balance, it's also independent of where the market moves.

Actually, a wise MM will hedge trades of its profitable traders on the interbank or with his liquidity-providers because otherwise he'd have to pay the profit out of his own pockets.

You are right in that leverage is one of the main issues on such days but there'd be no retail forex without leverage because forex industry deals in amounts that are way beyond the trade-capital of an average retail forex trader so getting rid of leverage or significantly reducing it would have detrimental effects on the existence of retail forex & overall liquidity leading to wider spreads. But what good brokers can think of doing is to reduce leverage for specific high-risk pairs, for example Dukasopy had reduced it to 10:1 for EURCHF, or they could find a way to insure clients' deposits to protect them against events like the other day.

It seems like there's still a lot of misunderstanding going around about the different retail broker business models.

The only reason why educated traders demanded any model like ECN, STP, etc. (business models in which their retail broker passes trades on to liquidity providers) as opposed to the traditional "MM"/dealer model (bucket shop/casino) is conflict of interest.

Nothing more, nothing less. Are there other advantages/disadvantages? Of course.

The first generation of retail Forex "brokers" (and that's using the term loosely, feel free to substitute "bucket shop" or "casino") were just streaming prices from the interbank market as a guide. So they essentially show you what the big boys are trading a currency pair at, and they let you buy and sell FROM THEM. Those trades never go anywhere else, least of all to a larger bank that actually trades with other major banks. That was the original "MM" / dealer model.

Here's the basic concept you need to understand: Any time you buy or sell any currency pair, your "broker" is ALWAYS on the opposite end.

That seems to trigger a lot of confusion for beginners because when they hear that their broker is "trading against you", they imagine that when you buy EURUSD, the broker somehow needs to do something like sell the EURUSD. No, they don't. They already did... TO YOU.

Example: At 2:00, you buy EURUSD. At 3:00, you sell EURUSD. If the EURUSD price goes up 10 pips, you win 10 pips and they lose 10 pips (they owe you the profits.) The broker never had to make a single transaction with anyone else for this to be true. If it had dropped, you owe them the profits.

What's the difference with ECN/STP/etc. models? (Ones in which the trade is passed on.)

Only one thing: When you buy EURUSD at 2:00, the ECN/STP broker (assuming they're really putting your trade through automatically and indescriminately as advertised) simultaneously buys the SAME AMOUNT of EURUSD from one of their liquidity providers. (A prime broker or larger institution that's further up the chain in the FX food chain.) And at 3:00 when you sell your EURUSD position, they also put a sell order of the same amount through to the liquidity providers.

The main differences?

1) They actually have no conflict of interest with you even if they technically are your counterparty (most still are and disclose as much in legal documents)

2) They actually do need to do something when you do something (you buy 1 of something, they buy 1 of something; you sell, they sell -- they themselves are never exposed because the amount they owe to the liquidity provider = the amount you owe them OR the amount they owe you = the amount the liquidity provider owes them.) Hence, no conflict of interest. They just may widen the spread a little for your side in an STP model or charge you a commission in a typical ECN model, or some other method of compensation based on your volume but not based on whether you win or lose.

The irony here is that FXCM and Alpari suffered for doing things "right" for the most part. (Of course, that wasn't always the case -- which is why FXCM has such a bad reputation among many experienced traders.)

What happened on Thursday was the actual interbank market actually lacked the participants to take the other sides of trades (the systems used to quote between the very top of the FX food chain went down during it -- freezes in MT4 and other retail platforms are just a domino effect of that, and peanuts compared to the kind of money at stake at the top.)

The other misconception is that there seems to be this idea that stop losses are a software feature and everyone gets confused when they don't "activate". They're orders. They're a lot like signing a piece of paper that says "If it doesn't start raining by Friday, shoot me." Well, if someone in Southern California signed that stop loss order in 2014, they'd probably be shot -- assuming other people are around to do it. But if there's a major earthquake that takes everyone else out (equivalent to Thursday's liquidity situation in FX) then who's around to shoot you?

In ECN/STP models, you actually need someone else to do it. In MM/dealer models, they'll be happy to shoot you themselves

Anyway, this Thursday did create a rare situation where brokers who have a direct conflict of interest with you turned out to be better (for the customers who had no direct position in CHF pairs)... because when you (if you traded CHF) and all other customers who did the same drops to zero, they already have your money. All they have to do is keep it.

For ECN/STP, if the same happens, they themselves owe that loss to liquidity providers WHILE you owe them. (Customer loses $X amount from CHF move; ECN/STP broker automatically had that equivalent trade put through to their liquidity providers so they themselves owe that same $X minus commissions/widened spread to the liquidity provider.)

Of course, when thousands of customers' accounts go negative, even if they don't guarantee against negative balances (because nobody was on the other wide of the stop loss trades -- ie. no one there to shoot you), it's not exactly practical for them to sue for the small amounts each customer owes, so they end up just owing the liquidity provider while none of the customers will pay them back.

It's not that much better for you if you traded against the CHF move because, one way or another, you lose your money. It's only worse if you happen to be one of the other customers who DIDN'T trade is while your peers did. (Because the broker holding your account might be insolvent.)

So yeah, this is a rare case but in general, it's probably not a good idea to stick with MM/Dealer brokers as a rule if there's any chance they'll act on their conflict of interest (and we all know many do -- delayed quotes, leaning, artificial slippage, etc. adds up to much worse than commission and STP widened spread costs.)

Anyway, I dont take offence, so i hope others dont.It depend on how you look at it. If those brokers who do not have much capital or liquidity to handle so much leveraged accounts, they should have managed their risk well. It's like other brokers who are well capitalised took it as a blink of eye. It's similar to us, retail traders.Those who have a betting account, will also know that the book maker cap their payout when they winnings should exceed the payout.
It's quite similar to taking or giving out loan too, no matter in a business or individual perspective. Will you Or your entity able to handle it when something happen.

Hello. I was wondering about stop losses in the options world. In a long call or short put trade, the maximum loss would be the premium paid or stop loss from my understanding. Is there a worry that one could go into negative equity in these kinds of trade? I am not exactly sure who or how MMs and liquidity providers are governed by the OCC. (?)

I have been considering moving into options especially now with liquidity providers quoting way way below eurchf's supposedly floor of 1.2.