We invite to read the interview with Purple Trading’s CEO, David Varga. Purple Trading is a brokerage company working in full agency model (100% Straight-Through Processing) on Forex, indices, commodities and stocks. Purple Trading team has strong tech background as their company has its origins in fintech industry – Purple Technology. Therefore, I decided to use this opportunity and ask experts questions about what do brokers have under their hoods. The answer turned out to be extensive and interesting providing plenty of useful information about how brokers fuction and what is the reality of cooperation between traders and brokers. I warmly invite you to this read!
Marcin Nowogórski, Comparic’s editor:
Thank you for your time and will to share some details about the “kitchen view’ on brokerage operations. It is a famous Bismarck’s saying that people should not see how politics and sausages are made. Do you think that brokerage operations are the right view for traders?
David Varga, CEO Purple Tradingr:
Thank you very much for inviting me to this interview. We sometimes say “to have a look under the lid” here in Czech Republic and I would say there is definitely nothing wrong about it to explore this more. On the contrary, it might even be very helpful for traders to understand some of the main principles of how the market participants operate.
Unfortunately, nowadays it is not so easy to describe it properly. Every broker uses a different setup for its trading infrastructure, which means a different combination of the trading platform and/or of the bridge technology (which transfers the clients’ orders to liquidity providers) and controls all of this via different management systems. And therefore it is pretty hard to say what or how some brokers are doing something, unless you really see very deeply into its structures.
QUESTION: Are you saying that what’s under the lid of my broker is more or less unknown? But there are some models of how OTC broker may function.
Yes, So it’s important to understand those basic models first in order to dig deeper into the subject, but I will try to make it short:
The STP broker works as an agency, or an intermediary for clients trades. Its server receives the order from a client and transmits it to a 3rd party, which is called Liquidity Provider (LP). All of this is done within milliseconds and automatically nowadays of course, but by the way, this is why the official legal name for this investment service is called “reception and transmission of clients orders”. The order is then executed by the Liquidity Provider (who is responsible to make or find a counter-party for each order sent to him) and the confirmation of execution is sent back to the broker, and to the client eventually. For doing this the STP broker usually charges a commission for each trade or adds some mark-up on the raw spreads he is getting from its LP, and this is basically the only source of income for him.
Question: And MT4 broker uses bridge for that. Could you explain the concept of bridge? Is it only for routing orders? Or there are some other functionalities included?
Yes, because MT4 platform originally had limited options to be connected with a 3rd party subject, it was not easy to connect it with technical infrastructure of bigger financial institutions, usually communicating via so-called FIX protocol. That is why the technological providers must have developed “bridges”, which you can imagine as a messenger or literally a bridge that enables the MT4 server to communicate with servers of banks or non-bank liquidity providers.
The solutions from tech providers nowadays include also other advanced functions for brokers, and beside using the communication protocol, or providing them with just one set of data for reporting and accounting purposes (which is extra useful especially if you use more than 1 platform or more than 1 LP), they also allow brokers to use more LPs, working as aggregators. This is our case as well and this way we can use the best possible LPs for different types of instruments, and not be locked just by one LP.
And how is it with the Market Makers then?
Pure Market Maker broker on the other hand provides the liquidity to all his clients by himself and becomes the only counter-party for all its clients’ orders. Every order that reaches its server is being executed internally, within the books of such broker, which is called “dealing on own account” legally-wise. And things are obviously different here in terms of income. As the sole counter-party, such broker makes money from the cumulative losses of its clients, and primarily relies on the statistics that the majority of clients will lose their money in a relatively short time.
Then, there is also a third model, so called “hybrid” model, where the broker (its dealing department) tries to optimise the trading flow of its clients in order to make more money. It uses both types of execution, and transmits some part of the clients’ trades to LPs, while keeping another part of the trading flow on its own book. There are many different approaches to this, and statistics and ongoing monitoring of clients accounts play a significant role here.
So my MM broker is closely watching my every step?
The idea is simple – they try to isolate the trades with high probability of being profitable and hedge those with the LP. If you are profitable you are probably in their “watchzone”.
QUESTION: I’m hearing from LPs that so many brokers internalize the flow these days even though they are connected to them. Why would that be? Is it a desperate pursuit of profits in this highly competitive environment?
I would say that this hybrid model is widely used by brokers nowadays, either directly by themselves (for which they need a market maker license), or at the level of their parent company, which happens to become their liquidity provider.
Isn’t this situation similar to the case where an STP broker is sending orders to a bank who is a market maker – which is the usual thing for banks? Where is the line beyond which we can say that a conflict of interest starts to become a problem?
Technically yes, it is pretty much the same. But business-wise I would say no. If an STP, or even a hybrid broker uses the third party bank, which is a market maker, it is hard for this bank to make any manipulation with the trades. Because if the broker is monitoring this (which it should, in terms of best execution policy and in the best interest of its clients) and finds out, it will switch the bank, right?
However, if the parent company of the broker is also its LP, there is a potential conflict of interest and it may be tricky regarding the best execution requirements.
All right. And in case of a pure STP broker, what happens when the order reaches the LP? You mentioned that the LP is responsible to make or find the counter-party?
Yes, correct, but it is again not so simple. There are several different types of LPs and like always, each can have some pros and cons. For example it could be another broker, or a single bank, executing all the trades for you, either as a market maker or under the hybrid model. Secondly, it could be some sort of an exchange, correctly named as multilateral trading facility (MTF), which connects thousands of market participants and creates an environment where they compete for price and execution, so like I said, something similar to an exchange. And thirdly, it could be a so-called Prime of Prime broker. This type of liquidity provider aggregates the price feed from the interbank market and is connected to several investment banks, funds and other financial institutions, and so it basically pools their liquidity. That means it automatically chooses the best possible price and conditions for your trades and provides you with much wider market depth than in case of having just one single provider or market maker behind you. This option is more expensive for the broker, but it would be pretty much impossible for a retail broker to get connected to big market participants like this on its own and the advantages are obvious.
And your choice was…
We have experience with each of these, and ended up using the “Prime of Prime” (IS Prime) and MTF (LMAX) models happily after all. Even though there were some advantages with the other solutions, such as the significantly lower prices (raw spreads, trading commissions) for example, there were always some issues, disadvantages and even major technical problems bundled/attached that forced us to be changing several LPs over time. This happened for like five times already, until we found the current setup where we are happy for more than three years now. But we are still watching…
Brokers tend to brag about how many LPs they have and how tier 1 banks are among them. Is it really possible that small or medium size OTC broker who offer microlots uses liquidity from 13 biggest banks?
Yes, this may look weird, but like I said above, that is exactly why we are using the Prime of Prime type of LP. If we were on our own, we wouldn’t be able to mix liquidity from those big players.
Someone could say that executing orders in house was not only more profitable but also more reliable. You have no issues with LPs and you fully control the execution, being able to provide better experience to your clients. Is it really like that?
Well, it is a good question with not an easy answer. ☺ Firstly, I don’t think that being a market maker is easier or more reliable. It is a different business model which comes with different types of problems and threats. I’ve heard of multiple brokers who set their risk management wrongly and went bankrupt because of that, when for example some clients made millions in profits during extremely volatile market movements. And it also requires a different type of license, much more reporting and monitoring, extra staff etc.
Secondly, a market maker must “deal” with profitable clients somehow, especially if it wants to maximize its profits. Which means it must treat some clients differently, have procedures for this and so on. The STP broker usually treats all the clients and all the orders the same.
We hear about dishonest brokers all the time and most often it involves a market making abilities. Are there any honest market makers?
I have to say yes, I believe it is possible to find an honest and professional market maker. But it may be very hard to identify this, either for me or for the actual clients.
You already mentioned that it’s hard to tell which broker is doing what in their back office. And if my broker is a market maker, will he manipulate my trades or the market against me?
The fact is that pretty much every market maker is affecting clients’ trades somehow, since it has to process those trades and it creates the actual market for them, as its name indicates. 🙂 So the broker must create the market depth in order to simulate a real market execution and protect himself against the latency arbitrage for example, and it doesn’t necessarily mean they are bad. The question is what is “enough”?
And what is enough?
As we said, the market maker is executing the clients’ trades internally and creates a counter-party to those trades. That means the execution for each trade, no matter the market conditions, can be literally done immediately (instant execution), there is no need to wait for the order to be executed with the LP (market execution). However having a really instant execution can be easily misused. There are trading strategies based on a so called latency arbitrage that compare slight differences in pricing between several brokers and could perform very well in case of instant execution. Therefore a market maker might want to simulate STP execution by slightly delaying order execution as it would happen in STP model when the order would need to travel to another datacenter where it would be executed with another entity which would take tens or hundreds of milliseconds extra time as opposed to instant execution. This in turn protects the market maker against latency arbitrage.
Sounds like flipping the problem and now traders are exploiting poor market makers and they need to protect themselves?
There could be other tools that allow brokers to affect the amount of slippage the traders are getting (on positive and negative end), to set the minimum offset for placing and moving StopLosses, etc. The bottom line is the following: there is practically anything that brokers can program and plug-in to their server nowadays, so virtually anything that can affect the trading and clients’ orders somehow and you can imagine it, can be done. And since most of such tools could be used both to benefit or to damage the clients, it obviously depends on who is using them and with what intentions. And that we can only speculate about…
What about artificial delay, asymmetric slippage, server disconnections during macro data releases and strange prices aka ‘bad ticks’? Traders complain about it on the internet. It sounds like many market makers overdone with the protection. Can you elaborate more on those alleged tricks?
Wel, I cannot think of many other, but isn’t that enough? Like I said though, it always depends on who is using such tools and why.
And what about hybrids? Simply combining both models? But isn’t it that they can be either a Market Maker or the STP for you, and it’s them to choose without asking you. So they would always choose the option that is better for them and a client always ends up with inconvenient disadvantages?
Yes, that is one of the risks I pointed out above. You as a trader are trying to optimize your strategy for certain conditions but then the broker is changing them at its own discretion.
We keep saying “we welcome also profitable traders” because we don’t adjust the trading conditions depending on clients’ profitability anyhow and we treat everyone and each order the same in terms of execution.
If you’re saying that it’s hard to tell how broker manages his clients’ orders is there any chance for client to find out which model their broker uses?
Yes, this might actually not be that difficult and there are several ways how to do so.
Firstly, the STP brokers usually tell it to you, as they use it for claims on their website or for promotion. In a better case, they will also publicly disclose who their LPs are, and some of them even transparently disclose some statistics, such as average spreads, time of execution, distribution of negative vs. positive slippages etc. And this for instance is exactly what we do in Purple Trading and you can check it out here. On the contrary, market makers usually don’t shout out the truth about themselves loudly and aren’t usually much transparent.
Secondly, you can check out the type of license the broker has. This can be verified on the website of the regulator and like I explained in the beginning, if the broker doesn’t have the “Dealing on own account” license it means it cannot be a market maker itself. If it has it then there is a big chance such broker is either a pure market maker or uses a hybrid model. For example again, you can check our record on CySEC’s website – there is only the “Reception and transmission of orders” + “Execution” + “Portfolio management” types of license. No “Dealing on own account in our case.
And thirdly, there is one more extra step that could help you to understand how certain broker operates. Because recently, after the MiFID II became effective, regulated investment firms in EU must publicly disclose even where exactly they execute the clients orders, or to be specific, the top 5 execution venues they used during each year, including themselves (if they market make it). Such report is called RTS28 and each broker must publish it somewhere on its website. I believe not many people know about this but it is a very good source of information. And again, as an example, you can have a look at our RTS28 report where you can see we used 4 different LPs to execute our clients’ trades last year for example.
I wonder why would anybody use market maker’s services when they can choose STP?
Well, that would be too convenient for me to simply say yes. ☺ But there is nothing like the “best broker for everyone”, things are not black or white.
I think a solid market maker could be a good choice for some traders. Those who can benefit from its advantages and live out with its disadvantages. Extremely low trading costs, fixed spread or even no swaps and instant trading execution is something that can be essential for certain trading strategies and something that a proper STP broker cannot offer by any chance. On the other hand, such traders also have to count with the fact that in case they are going to make money, the market maker can stop providing services to them or switch them to an STP model with potentially different conditions. And that means they might need to adjust their strategy or look for another market maker and the circle keeps repeating.
I personally know few traders, whose trading approach is based on exploiting the market makers with poorly set technology, delayed price feeds or instant execution. They open an account, make several thousands dollars until the broker notices them, then it closes their account and they have to move on to someone else. Their trading could never work on real market STP conditions but they are fine with this never-ending circle.
On the other hand, if a trader looks for a long-term stable partner, a broker whose intentions are in line with his own and where he will most probably get the best possible services and care, STP broker is a better choice. Because let’s be honest, we STP brokers cannot compete with market makers by price, we cannot really make trading swap-free, offer deposit bonuses or have special offers such as “trade DAX with half-spread”, and therefore our only chance is to provide our clients with the top-notch services, always add something extra and really treat our clients with the best possible care.
So for me the decision between an STP or MM broker, or the ultimate questions to be asked in this regard probably remain the fundamental ones – Is trading a game for you or do you take it seriously and want to be successful in a long term? Do you want a broker that supports this and that you can believe in? Is there any point in trying and testing your strategy on certain conditions and once becoming successful to be switched to different ones? Do you want a broker that will be your competitor or the one who is your partner in the long run?
So let me twist it now and ask, why would any broker resign of market maker powers and become a pure STP like you guys?
We believe it is more beneficial over the long term. We want to build the business based on long term relationships with our partners and with our clients. This is how I was raised and how I act in my personal life. That is why we want our clients to be more successful, we offer them a loyalty program, we provide them with useful tools and features (and the list of them is being continuously extended), with excellent execution conditions and we fully support them in their trading journey. Including the one towards being a professional. We give our clients a chance to become the Strategy Provider, and if that happens, we can copy their strategy to hundreds or thousands of following investors. This way they can make living out of trading even without having millions on their own account.
So when you think about it, a vision like this cannot be in line with a market maker setup, it doesn’t make sense philosophically, morally nor commercially.