Brokers, A-book, B-book, tilting and other stuff…
If you want to become a successful trader, then it is imperative for you to understand the game. And the most important player in this game is your broker, therefore you need to understand how this industry works.
Speaking of industry, I mean trading platform providers, liquidity pools and banks, market makers, brokers, etc… You broker is a first link in the chain of institutions that eventually provides you access to markets and enables you to take your trades with a click of a button.
I will mostly focus on forex brokers but the concept is broad and relevant to others as well.
A-Booking vs B-Booking
The first thing you need to understand is the broker’s business model. And the widely misunderstood concept here is so-called A-booking and B-booking. Not so many traders and even professionals can explain mechanics of broker’s business.
The term refers to the difference in methods which brokers utilize in taking and filling your orders, as well as handling their own market risks. It essentially defines the way broker makes money.
Let’s be clear. Most brokers in the world use the some combination of A-Book and B-Book methods. It is always about risk and profitability to them and besides, all the techniques described below are perfectly legal. So, why to be shy ? Business is business.
A-Book simply means that your buy or sell order is accepted by your broker and then passed through further to the market to be filled by the next institution in the market “chain”. A-broker normally will not take the other side of your trade. They act as the “true broker”, which means they serve as a mediator between you and those who provide the liquidity and assume market risk.
Imagine you want to buy some amount of EURUSD, so you click the BUY button and the next moment your broker places this order with its partner bank. Then bank fills your order. It is that simple. Or your broker will take this trade selling you EURUSD and simultaneously buying the same amount of EURUSD from the same bank. This is more complicated but essentially is the same. The key word here is simultaneously. In both cases, A-broker will never assume a market risk.
In our example this next institution is a bank, but it could be any other type of market-maker or in other terms “liquidity provider”. By the way, sometimes it could be just another and bigger A-broker. But even in this case, it is important to understand that no matter what type of broker do you work with, eventually your order will end up with market maker. The function of market maker is to quote two-way price and fill orders thus taking the other side of your trade. That means market maker takes the market risk and has market exposure.
As you can see, A-broker business is simple – they mostly make money on spreads and commissions. There could be other fees too: rollover mark-ups, position financing costs, subscriptions fees, platform fees. A-brokers won’t benefit from trader’s lost money as they are taking any exposure.
A-broker wants you to continue trading big time and ideally forever – so that he can keep making money on commission and spreads. Therefore, A-brokers will be very worried if your account goes down quickly. They will call you every day, they will send you analytics, they will teach you to place stop-losses. They always pretend to be your best friend but, of course, all they care about is to keep you trading.
In short, this business model is offering the market access services and gets paid for that. Which is what most traders regard as “fair business”.
Now, because of this common misconception so many traders are looking for A-brokers. Some people are really obsessed with the fact that the broker will earn money while they lose. But, frankly, it is not that simple.
A-brokers will have some issues too:
- Slippage is often higher than with other types of brokers and spreads will often widen whenever there are market news and generally during any type of volatile markets. Remember, spreads is their major profit source.
Trading costs (spreads and commissions) are very often higher than with another type of brokers. A-brokers will normally charge you minimum tickets fees. They do not like you to trade small.
Many A-brokers will do price “tilting”. We will discuss this later in this article, but essentially “tilting” means that brokers will “move the market” against you.
Instead of dealing with intermediary or agent, now you deal with the liquidity source. They won’t pass your order further, instead, they will quote the price to you and they will fill your order from their own balance sheet. And – this is important – they will take the exposure risk against your trade. B-broker will be your market.
B-broker takes other side of trade and many traders believe this results in conflict of interests, is unethical and wrong. That B-brokers trade against their clients. All the traders’ rage in the world is focused on B-book brokers.
But it is not that simple. Let’s look closer at broker business mechanics.
How brokers handle your orders ?
First of all, there is so-called internal liquidity. Bigger brokers nowadays servicing many tens of thousands of active clients and typically receive huge order flow at any given moment. During normal market situations the order flow is mostly balanced and at any given moment there are many clients simultaneously sending buy and sell orders. For example, one (or more) clients buys EURUSD and at the same time others clients sell. The broker creates a trading venue and those buy and sell orders are matched against each other. The broker’s internal book operates almost like an exchange trading book. Alternatively, the broker takes another side of each client’s trade and then acts as a clearing house for all those internal trades. Result is pretty much the same.
Of course, the balance is never perfect and usually broker always have some market exposure (risk) against entire client’s pool. But most B-brokers will dynamically and in real time hedge this exposure with own liquidity providers. No any serious broker would ever dare to risk his business having unhedged massive market exposure – especially during volatile market situation.
The technology of dynamic hedge vary from broker to broker and it is often a closely guarded proprietary science.
Because of this order flow handling and overall better profitability, B-brokers usually offer better spreads and commissions. Their slippage is lower too and prices are more stable. With B-brokers quotes often guaranteed and execution is better.
Well, B-brokers also have issues. They inherently allow higher leverage and also encourage to trade recklessly. They also engage in “tilting”. Besides, if B-broker fails to efficiently hedge its dynamic exposure, the business (and clients’ money) is at risk.
Hybrid Broker Model
Most brokers nowadays are so-called hybrid brokers. It simply means that they run both A-book and B-book and regularly re-distribute clients and trades among both.
Hybrid brokers will keep smaller and losing traders in B-book and pass on orders of profitable traders and big accounts holders to A-book. as a result, Hybrid brokers will redistribute the risk and optimize the profits. They routinely collect and use statistics and employ algos to re-classify accounts based on clients’ trading style, profitability, account size, trade frequency, whether trader uses stops or not, etc…
How to guess your broker type ?
As a client, you probably never will which book you’re on.
As a rule of thumb, bigger accounts are placed on A-Book due to the higher risk for broker. On the other hand, if your account is small, the odds are that your trades are executed on B-Book.
How can you guess ?
If your trades are being filled quickly during a major news release or quick market and no re-quotes, then it is likely you are on B-Book. Usually liquidity dries up during times of high volatility, so it’s harder to find a counter-party (market-maker) to fill your trade. However, on B-Book this is not an issue because broker takes other side of trade or use internal liquidity. So, order will be filled instantly.
But is that so much important ?
I do not think so. If my broker is reliable and price feed is stable, execution is smooth and liquidity is sufficient, trading costs are low, trading platform is nice and I can withdraw money without any problem – so why should I be concerned with the fact that I am on B-book ? Just because the broker takes other side of trade and my loss is broker’s win ?
All I care about is my profitability.
A little insight on how brokers make money
Brokers broadcast the price feed to your trading platform – the bid and ask quotes received from market maker. The spread you get is much wider than the spread broker receives from liquidity provider. Further, broker gets liquidity from many providers which allows him to create very narrow “core” spread.
This difference between core spread and clients’ spread is a bread-and-butter for brokers.
Ok, these are basics. Now, question is what else they do?
A-broker will fully hedge every trade almost at the very moment client’s order is filled. This broker will earn on spreads and commissions on trades. However, this business is sufficiently profitable only if broker’s client base is huge and active. Also, it is vital for this broker to attract a regular inflow of new clients – because, statistics prove that sooner or later most of those accounts will be busted.
Then how to maintain and even increase this profitability? One popular way is tilting.
While filling the order Broker can move market against client.There are many different methods of tilting but let me give you an example.
Let’s assume you entered long EURUSD and this trade has been hedged by your A-broker. Because now you are long, at some time in future you will inevitably close this position – with profit or loss. To close position you will send the Sell order.
Now, this information creates certainty and any certainty on the market can be exploited. Broker knows that you will sell EURUSD at bid price and broker will start broadcasting bids on your platform a little bit skewed or “tilted” down. In other words, bid price you get will be a half-pip or pip or even two pips lower that the quote that you would otherwise gotten.
When you decide to close position and send the Sell order, it will be filled at “tilted down” price, worse than prevailing market bid. At the same time broker will release its hedge by closing the same trade with market-maker at a higher price. This is a good profit add-on to existing spread-mark-up.
So, whenever you send the market order to broker, there is a way to move market against you. You lose and broker earn additional pips or two.
Therefore, you should be skeptical when brokers advertise spreads “as low as 0.2 pips” or declare “we reduce spread personally for you”. This reduction is compensated by regular tilting.
There are many ways of tilting designed for every market condition and trade circumstances, for opening and closing trades, for different type of orders, etc…
Tilting can be done manually by dealers and automatically. There are special algorithms built into quoting servers and this algos modify bids and asks that you see on your trading platform. It can be done on individual account level. For example, if your friend is client of the same broker, you can often see his pricing is slightly different. One of the reasons for that is tilting.
How a broker can benefit from delayed hedge?
Hedging all clients’ trades immediately and in real time is the safest way of business for broker. This is what most conservative brokers do, however, some aggressive brokers use delayed hedge.
This concept is based on the fact that with absolute majority of traders the biggest losses normally occur within several days after trade is initiated and very rarely on the same day.
This is statistically and empirically proven. Trades that are opened and closed during a day are usually safe for a broker, therefore broker skips hedging all newly opened positions during that day. As a result, most new trades are placed in B-book.
Few days later, when this particular client loses 25% of his money (or whatever pre-defined level), a broker will hedge this position with market-maker. Now, client’s loss is pocketed by broker and the position is finally hedged. Broker is safe and his risk with this position becomes zero.
Another hedge trick
If you have ever traded, you probably noticed that new trade almost never goes in your direction. Almost every position you take will at first go against you and for some time you are in loss. No trader ( except scalpers) will close trade at 10-15 pips loss. It makes no sense, right? Trade will mature and profit will come later.
If broker did not hedge your trade immediately at entry, then your loss is broker’s profit. Here is the very smart hedge employed by brokers – since almost every new position is in loss some time after initiation, then why to hedge it immediately? Wait for some 10-15 pips (or even less) of loss on traders account (which is profit for broker) and hedge it afterwards.
This is relatively safe and statistically proven hedge technology and at the same time, if employed massively, brings amazing profits.
So what is a bucket-shop?
B-broker and bucket-shop are not the same. Bucket-shops are scam. Their business concept is simple – small deposits and very high leverage combined with market volatility and trader’s ignorance will blow-up 99 percent of accounts. There is no need to hedge risks. Bucket shops register all client trades in own book and all trades are basically virtual. They pocket everything that client loses.
Again, this is how bucket-shops looked like in 90s. Nowadays, bucket shops are a little more sophisticated, yet…they are bucket-shops.
How to identify true bucket-shop?
- very high leverage – 1:200 and even more
- very small minimum deposits allowed
extremely difficult and almost impossible to get your money back. Bucket-shops will use every reason to stop withdrawals.
- licensed in remote jurisdictions
- profitable traders are not welcomed. They may even ask you to close the account and leave – if you are profitable.
In recent years the number of bucket-shop decreased substantially thanks to regulators’ efforts. However, capitalizing on peoples greed and ignorance, bucket-shops are still over here.
What broker is best for you?
Most important factors you should consider when choosing a broker and I call this three R – reputation, reliability and regulation. Think about it – you want to be sure your money is safe even before you started trading. You want it to be a well regulated, reputable and financially sound broker.
I will also look into following:
- spreads and commissions – because it is important to have your trading costs at the lowest possible levels
- execution quality, transparent and precise price feed, less re-quotes
- how fast and smooth they process money withdrawal
But I won’t be much obsessed with A-brokers. Because frankly, it is not relevant. Many A-brokers do tilting, widen spreads and their liquidity may dry up under fast market conditions. We defined that A-broker passes on your order to the market-makers. But here is the thing – eventually your order will end up with market-maker which will take the other side of the trade. This is a nature of the OTC industry. So what is all the fuss about?
Whether you will earn money or lose – this is important and is entirely up to you. If your trading strategy is sound, if you can realize your trading edge and discipline – then the business model of your broker is irrelevant.