If you’re using an arbitrage trading program, you probably know that choosing a broker can be tricky. I would like to help you choose the right broker for arbitrage trading and do it properly. It is held by some that arbitrage trading programs work well in demo accounts but are mostly useless in real accounts, so there is little sense in testing these programs in real accounts. This is only partially true. I’d certainly recommend testing an arbitrage program in a demo account first: it will help you understand how the program works and determine whether or not your parameters have been set correctly. For example, if the program does not lead to successful trading results in a demo account, you’re either using a broker with very fast quotes, which is quite rare, or your parameters are off. So the use of a demo account will help you adjust your parameters correctly before proceeding to test the program in a real account.
It’s worth discussing briefly how MT4 brokers actually work. Dealing with such a broker involves using an MT4 terminal on your end, which is connected to an MT4 server via an internal MT4 protocol; this connection is used to transmit your orders as well as quotes, error messages and other trading-related information. When you place a buy or a sell order, or when your robot does so, the order is first transmitted to the MT4 server; the server processes the order, executes it, and relays a fill confirmation back to you.
I’ve already mentioned the use of the B-Book by forex brokers. A B-book is used to house all accounts whose orders are executed “in house”; in other words, these orders are filled internally, never leaving the brokerage firm. It’s a fair estimate to say that, as far as most brokers are concerned, 95-99% of all trading accounts end up in the B-Book.
That said, every broker works differently. Some brokers only have an A-book, and there are quite a few of those. Other brokers might have both an A-book and a B-book, which allows the broker to switch accounts between the A-book and the B-book, a decision that is based on the algorithm that is used by that particular broker. Here, too, practices vary from broker to broker. The broker might make automatic switches from one book to the other if there is an increase in the lot size. For example, the broker can assume risk if the trader uses a lot size of 0.1, but automatically switch an order to the A-book if it is placed with a lot size of 1. A switch from the B-book to the A-book can also be based on the deposit size. For example, if the trader puts up a large deposit, the broker might be unwilling to be exposed to the risk involved in such a deposit and will therefore switch the account to the A-book.
Switches can also be informed by trading results. This is probably the most common reason behind switches between the two books. The MO is as follows. The broker makes an assessment of the trader’s performance. If the broker sees that the trader is losing money, the account will stay in the B-book; if, however, the assessment reveals that the trader is using a strategy that makes money for the trader and does so on a steady basis, the account is switched to the A-book. Alternatively, the broker might also resort to several methods that will obliterate the successful trading strategy. For instance, the broker might widen spreads, or increase order execution time or slippage, etc. An experienced trader has to take into account all of these factors when working with a broker to ensure that the account stays in the B-book or, if the account ends up in the A-book, at least protect the account from anti-arbitrage tactics that can be used by the broker.
Once the program has been tested in a demo account, it’s time to move to a real account. I should also add that many of our clients decide to test their trading programs either on a home PC or via a cheap VPS before upgrading to a recommended VPS. This approach is doomed from the start. Success in arbitrage trading usually depends on choosing the right VPS. This is due to the fact that the transmission of orders is highly sensitive to the distance between the broker and the trader’s program, which should be minimal. It therefore pays to go with a VPS that is located in the same data center that is used by your broker.
So you’ve tested your program and are now ready to go live with a real account. You’d be well advised to start off with a small lot. If you find that the arbitrage program works well with small lots, then increase your lot gradually, by laddering it, which should serve you well if your broker switches accounts from the B-Book to the A-book based on the lot size: laddering your lot size will help you stay in the right book permanently.
Also, it’s worth bearing in mind that many new brokers constantly crop up, sometimes almost on a daily basis. These brokers typically do not yet have the benefit of experienced dealers or the necessary systems that can suppress arbitrage systems, so it’s a good idea to keep tabs on new arrivals, as your arbitrage system is bound to perform well with such brokers.
How should you approach your broker selection when using lockin arbitrage and two-legs arbitrage? With lockin arbitrage, you need two slow brokers, which will prevent either one of the brokers from identifying your strategy as an arbitrage one; so the choice comes down to choosing two slow brokers that have been shown to work well, profits-wise, with arbitrage programs over long periods of time. Once you’ve spent some time trading with lockin arbitrage, you can try two-legs arbitrage, using the same accounts, currency pairs and lot sizes. It is advisable to use two-legs arbitrage in the account that is slightly in negative territory: occasionally, with arbitrage trading, a situation arises where one of the accounts is in positive territory, while the other one is in negative territory. Using two-legs arbitrage in the one that is in negative territory is unlikely to irritate the broker as much as it would if you were to do the opposite. However, we don’t recommend engaging in two-legs arbitrage until you have spent four weeks using lockin arbitrage.
If you decide to use hedge arbitrage (two-legs arbitrage), you’ll need two brokers: a fast broker and a slow one. For the fast broker, you will also need a FIX API account. Moreover, the FIX API account should be unthroattled in other words, it should be “unfiltered”. What does that mean? A standard account has 50-100 updates per second, which is not quite suitable for two-legs arbitrage. It is better to use an unfiltered account; Such providers as ultrafxvps.com and beeksfx.com provide a cross-connection to fix api brokers servers, and you’ll be able to obtain a unthroattled account. The second broker should be a slow one, and you should choose it the same way you choose your slow broker for lockin arbitrage.
To conclude, I’d like to give you the following tips with respect to broker selection:
- Evaluate new brokers that have just opened doors.
- Test your broker by starting with a small lot size, which you should increase gradually.
- If you have accounts that are in negative territory, try your arbitrage trading in these accounts first.
- Constantly test your system with another broker while trading with the existing one – your existing broker might stop working at any time, so you’ll be able to move your trading to the latest broker without any interruptions to your trading.
- If your arbitrage strategy works, do not publicize your results anywhere (especially on Internet forums, etc.) and avoid naming the broker you’re using. Any indiscretions in this regard can help the broker identify your trading strategy as an arbitrage system and put an end to it.
- Never reveal to the broker that you’re planning on using an arbitrage strategy, even if the broker seems to be amenable to some kind of arrangement. While the broker might express agreement, you have now been flagged and will never be able to make money with that broker. In that respect, the broker is decidedly not your friend.
I am confident that the above will help you in your broker selection. Good luck in your trading!
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