Beware of market makers

by | Feb 4, 2019 | Forex, Stocks/ETFs | 0 comments

Are you using a broker or a market maker? If you do not know what I am talking about, better to read this article.

One of the first choices you have to make when you start trading/investing is the broker. This applies to various assets, e.g., stocks, ETFs, Forex. You may have noticed that some of them offer conditions very attractive: low commissions, zero inactivity fees, very high leverage. How is it possible? Probably they are not brokers, but market makers.

So what is the difference between a broker and a market maker (MM)? The former charges you a fix or variable commission to send your order to an exchange where all the other market participants can buy/sell. This is also called DMA (Direct Market Access). The latter does not send your order to the market. Rather, the market maker is the market, meaning that it will be the one filling your orders. Hence, when you buy, MM will sell to you. And when you sell, MM will buy from you. What is wrong about that, you may wonder?

  • Statistics tell us that 90% of people lose 90% of money within 90 days (90-90-90 rule, remember the home page?). Since MM is taking the other side of your trades, you now know who is making the money you lose. No wonder you are offered such attractive conditions to trade as much as possible – MM will take your money faster.
  • Usually, the price offered by an MM replicates more or less the price of the underlying asset. However, this is not mandatory. In times of high volatility, this may not be true, and you could experience some issues. For example, your stop-loss could be triggered even though the price of the underlying never reached that level.



Who is getting rich? You or your broker?

This does not mean that market makers are evil. However, you have to understand that they are way less regulated than normal brokers. Hence, it is possible to have discrepancies between the price they offer and the real price of the underlying asset. Is this a good price to pay for low commissions and the other advantages they provide? The choice is yours.

Personally, I suggest you to avoid using MM, especially if you are starting. If you want to use CFD, at least ensure that they are CFD-DMA (for example Interactive Brokers). If you want to trade Forex, you can do it through Futures, that are regulated. We can go more into details on these topics, just let me know with a comment below.