How Does an NDD Actually Work?

There are many keys to understanding the Forex markets, and there are many parallels between the Forex markets today and the stock market back in 1995 and 1996 when ECN technology like ISLD and ARCA were coming about. The non-deal-desk system is the really the beginning step of the process of making the Forex markets a truly “transparent” market with “best pricing” available electronically straight to the customer. In order for there to ultimately be a true market for Forex (such as exists for stocks and futures); companies will need to take several steps to move away from the traditional deal desk systems. I’d like to discuss many of those steps now.

I do want to say up front that I work for a non-deal-desk platform (EFX GROUP / MBTF). I don’t want there to be any confusion about that. If someone thinks that any of my points are biased because I work for a NDD platform and not a traditional deal desk platform, I’d be happy to discuss it with them here or in private, and I will respond to any comments/questions.

These are the things that I think separate a true NDD platform, such as ours, from other platforms, and then I have some comments about the Forex market and the average Forex trader beyond that.

1)      Direct access to the biggest piece of the market possible. When an NDD platform executes a trade, it is executed purely electronically, without bias, without human intervention, and at the best price that our system could find at the time. I think this little fact is something that people overlook. We are paid on the commission on the trade, just like in the stock, futures, and options markets. Our incentive is therefore to get the best price possible to keep the customers happy. We have interest in the spreads being tight and the executions being the best that they can be. In fact, the better that we do for our clients, the better that we do overall.

2)      A related point here is therefore anonymity. Execution should be no different whether you are closing or opening a trade. The system should not care where the trade is coming from. It should not care whether that person is starting a new position or closing an existing one in the same direction. A true NDD platform shouldn’t care who the trade is coming from when it executes. I can tell you right now that when it comes to the EFX GROUP / MBTF system, a sell order to close a long position and a short order that are put in simultaneously on the EURUSD will be filled at the prevailing market price together, period.

3)      No requoting. A non-deal-desk system lets you know everything that they are making from the trade. Personally, I would rather trade on a system that lets me get executed by the true market, which includes customers and banks, with the narrowest spreads possible, and get charged a fee.

4)      ECN vs. STP vs. Deal Desk. It needs to be made clear that there are really more than two types of platforms. A deal desk is a fixed spread platform where the desk makes their money in the spread or by taking on the risk by absorbing the position into its book. STP (Straight Through Processing) platforms execute directly from the retail client to the banks. The more banks and liquidity in the system, the better the fills for the customer. ECN (Electronic Communications Network) platforms let customer orders interact with other customer orders. Non-deal-desk (NDD) platforms are either the second or third type of platform. EFX GROUP / MBTF are both. We have over a dozen banks in our network which customers execute against directly (STP), but we now also allow customers to hit other customers (ECN) inside of the standard pip increments of the banks. We do not shave anything against customer executions.

Having said all of that, I’d like to make a few additional points about the Forex markets, execution, and our platform.  In reality, the retail Forex world is made up largely of unsophisticated traders who have not traded anything before. You can usually recognize these people because they are looking to trade at higher margin levels and expect executions that the market cannot provide. The Forex markets are more highly leveraged than the futures market. We offer 100 to 1 leverage. Professionals rarely use 20 to 1 leverage. Retail traders with no experience are constantly looking for higher leverage, up to 400 to 1, which shows their lack of experience. Few of these traders last long in the Forex markets.  In addition, there are many people who think that they are “entitled” to fills because they want to buy at certain prices. This happens most commonly on “news spikes” due to economic data. People try to place market orders on the news and then are surprised if their fills arrive within a split second, but 30 or 40 or 50 pips away from where the market was before the news. Few of these people actually understand what they are trading. Let’s consider a few points.

In exchange rate terms, $0.01 of movement between the Euro and USD is 100 pips. That means that if news comes out and the EURUSD moves 30 pips in a second, that’s $0.003. In other words, it is not measurable in real terms. However, a trader trading at 100 to 1 margin may expect that they should be filled at a price that existed before the news hit. When I ask traders if they would be willing to sell the EURUSD at the price it was trading at before news hit that caused a 30 pip spike, they say no. But they expect that banks will make those prices available. In other words, they aren’t willing to accept the consequences of a “market.” Trading on economic news in the Forex world is the most dangerous type of trading that one can do. Having said that, let’s consider what NDD platforms offer to protect the trader.

STP and ECN platforms (which are both NDD platforms) execute any marketable orders instantaneously. That means if you are a buyer at the market and there is a seller at a price and no one has bought from him/her ahead of you, you are filled at that price. It is a true market. There is nothing that says that you deserved to get filled 20 pips back because that would have made you money.

The Forex market has come a long way in the last two years. Traders should look for platforms that offer the following:

1)      Fraud protection in the form of Fidelity bonds.

2)      Segregation of client money.

3)      True executions.

4)      Lots of liquidity.

5)      A good variety of order types, which professional traders should use to control their risk. No one should EVER place a market order when they can limit themselves to fills 5 or 10 pips above the market.

On a true STP/ECN Forex platform, no trader that understands executions should ever have issues with getting extremely bad fills (slippage). Everything should be in-line.

I have spent a lot of time watching thousands of people trade the Forex markets. Forex is a very exciting market with massive liquidity. With platforms like EFX GROUP / MBTF, which offer true STP and ECN technology, it should be a true “trader’s market,” as long as that doesn’t suggest to traders that they are entitled to fills that don’t exist in fast markets or that reckless use of market orders should always be rewarded.

When the exchange rate between the Euro and the US Dollar moves $0.01 in a day, that’s 100 pips. This is a microscopic move that is only remotely tradable because of the leverage used in the Forex markets. I think a lot of people have expectations that go well beyond reason when it comes to the Forex markets.  I think that things are moving closer to a centralized market place with good regulation about the limits to which a seller or buyer can price themselves away from the market but still fill a retail client. I think within a year or two, platforms like EFX GROUP / MBTF will have completely altered the landscape of Forex just like ISLD and ARCA did in the US stock market back in 1995-7. In the meantime, stick to the platform that safeguards your money, gives you the most options, and provides you with direct, unhindered access to the liquidity that is out there. Make sure that your funds are secure from fraud and protected from co-mingling with your platform. Make sure that your funds are held on-shore, not off-shore. With all of that, it’s just about your trading skills.

Justin LeBlang

V.P. of Business Development