A Broken Broker?

Forex broker FXCM have recently caused a bit of a stir by apparently changing their policy of guaranteed stops. We take a look at why, and what this means for the forex trader.

Were they ever really fixed?

With more than 50,000 accounts, FXCM are one of the larger forex brokers, and are well know among currency traders for their almost unique policy of guaranteed stop orders. In short, it has always been understood that any stop or limit order would be filled at the price entered regardless of how quickly the market price may move to  - or through - the stop price. In the forex market, where prices can move several hundred pips in a matter of minutes on big news, such a guarantee is valuable indeed. Now in a recent email to all of their clients, FXCM appear to have backed out of this policy, stating that "we cannot provide execution guarantees for stop-loss, limit, and entry orders." But were the stops ever really fixed in the first place?

Despite the guarantee being the understanding of the all of clients we spoke to, FXCM themselves seem to think not; they back up this stance with a quote from their website disclaimer which says "All stop-loss, limit and entry orders are guaranteed against slippage except in extraordinarily volatile market conditions." It's easy to see where the confusion lies, as in a more prominent position on the same website we find the boast that "At FXCM you receive no slippage on stops and limits regardless of trade size. Other brokers claim to guarantee fills on stop orders but if you check the fine print they only back this claim for small trade sizes during normal market conditions. Many brokers routinely execute stops 5 to 15 pips away from the stop price. Only FXCM honors the exact specified stop level at all times." An apparent discrepancy that could no doubt have some highly paid lawyers arguing for the some time then.

Broker or Broke?

So just why would a successful brokerage firm want to change the one policy that sets them apart from the crowd, or at least attempt to clarify that the policy does not actually mean what everyone thought it did? To understand that, it is necessary to understand that FXCM isn't truly a broker. In the pure sense of the term, a broker literally brokers a deal between a buyer and a seller, and takes a commission for their trouble. They have no interest in whether the buyer or the seller makes money from the transaction, their role is simply to facilitate it in the smoothest possible way. FXCM does not do this. In many cases - most in fact - they will take the position of the buyer or seller, i.e they will take the other side of your transaction, thus taking on risk. With so many clients each trading different systems, strategies, and timeframes, the trades that are being placed will largely offset each other and FXCM will hold a market neutral position overall. Should they find that they are significantly exposed to either the long or the short side, they will go to the interbank market and offset the balance there, to regain their neutral position. However, when the market moves rapidly, such as at times when big economic reports are released, they may find they are unable to balance their book quickly enough and will end up showing a loss. If all this makes FXCM sound like a bookmaker, it's because essentially that's exactly what they are - along with the majority of retail forex 'brokers'. It is clear then, that if FXCM and their kin do not have to fill all client orders at the exact price specified, they can recover at least some of any loss they may suffer whilst offsetting their position in a rapidly moving market.

So what now?

Until now, traders (at least all of those we have spoken to) have been under the impression that FXCM could guarantee stops by charging a wider spread - 5 pips on most pairs. This 'hidden' charge means that they take a couple of extra pips profit on most trades, to help offset any loss that might be incurred by filling a stop order at a price which is less than attractive to them if the market moves quickly in the wrong direction. If stop orders are not in fact guaranteed, then one must wonder if traders will continue to be willing to pay a wider spread for the same service that other firms are offering. Of course, there is more to a brokerage service than just their spread - see our article on choosing a forex broker for some of the other aspects a trader should consider.

What options does this leave the forex trader? Well not guaranteeing stops is actually considered normal practise in the retail forex market, so FXCM have not exactly turned themselves into the social outcast of the forex world that some commentators seem to be suggesting. However for those who absolutely must have fixed stops, there are still at least a couple of options remaining. Some of the spreadbet and CFD companies (CMC for example) will offer a guaranteed risk trade - for a few extra pips on the spread (although US laws mean that Americans need not apply). And now Interactive Brokers have opened up the true interbank forex market to small retail traders, offering a true currency trading brokerage service. This is a welcome move, and we hope will stimulate some real competition in the market place.