Some of the more frequently asked questions that we get from our users are why forex brokers are unreceptive towards arbitrage strategies and how to use arbitrage trading strategies without having to deal with broker intervention. Let’s look at a simple example. Let’s say you have US$100, and you need to have those funds converted into Canadian dollars or perhaps into euros. When you head to the nearest currency exchange bureau and take the money out of your wallet, the teller will certainly not decline your request to convert the funds because you’re supposedly engaging in arbitrage trading - even if the rate changes a few moments later to the dealer’s disadvantage. Why are things different with the forex market? Why do brokers either refuse to work with arbitrage traders outright or resort to stratagems that render such trading unprofitable?
There’s a simple explanation for why this happens. Many intermediaries on the forex market do not actually transmit the orders that they receive directly to the market. Instead they fill them internally. This practice does have its benefits, as these intermediaries do not need to pay commission fees themselves and are therefore able to make the market more competitive. If intermediaries engaged in this kind of internal clearing were to disappear, the price of foreign exchange conversions would rise. At the same time, traders often end up getting hurt in this situation since the intermediaries effectively trade against them (if the intermediary gains, the trader loses - and vice versa). There is an inherent conflict of interest at work here: the broker wants the trader to lose. As a consequence, for a forex broker filling orders internally, any successful trading strategy - not just an arbitrage strategy - is a problem, and the broker will erect obstacles to render the strategy uneffective and the trader using it unprofitable.
Typically, forex brokers rely on various plug-ins that obliterate arbitrage and scalping strategies. The only way to circumvent the effect of brokers’ plug-ins is by using long-term strategies that seek to capture a higher number of pips in profits on every trade. However, it will not do to cede control of the market to brokers by moving to long-term high-pip strategies. If traders abandon arbitrage and scalping strategies in favor of long-term strategies, which offer smaller profits but greater risk, unscrupulous operators will then target the long-term strategies. Forex brokers should not be the only ones to profit from the forex market; all participants should have a decent chance to make money. A market in which only brokers can win is an inefficient market.
We’ve often said that arbitrage trading strategies should be camouflaged. How is this done? If you use an arbitrage trading strategy when working with a broker, the broker - if it’s an ethical one - will transmit all orders to a liquidity provider. If you happen to be the only arbitrage trader in the flow of orders sent to the liquidity provider by the broker, your arbitrage strategy is not likely to make much of a dent in the liquidity provider’s profitability. There might be another 2,000-3,000 traders or so in the flow, all of whom are using other strategies such as grid strategies, Martingale strategies, etc. Most of these strategies are unprofitable - according to statistics, 90% of all trades end up as losses. Even if the liquidity provider is unscrupulous, your arbitrage trading will have only a small impact, and the liquidity provider will likely continue to work with the broker. You will be able to use your arbitrage trading strategy to your wallet’s content. Should you be joined by several other arbitrage traders, however, the risks will increase for the liquidity provider. At that point, the provider will either request that the broker identify the arbitrage traders, or the provider will modify the trading environment for the broker (usually by introducing slippage or delays into order fills sent by that broker).
On the other hand, as the number of your arbitrage orders goes down, your trading activity will be considered as less “toxic”, and therefore more attractive, by the broker and the liquidity provider. Additionally, the more volume you send to the broker, the greater the commission fees earned by the broker and the liquidity provider. Consequently, they will want you to trade with them for as long as possible. In that case, the liquidity provider might send your orders externally directly to the market, passing on the risks to the next market participant (e.g., the bank) and letting you continue using your arbitrage strategy. For this to happen, you need to show your broker some robust volume. If you show high trading volumes, the broker will be a lot more accommodating in order to keep your business. Equally, the liquidity provider will also be willing to reach an agreement with a broker that offers higher trading volumes. Your primary objective, then, is to provide a healthy trading volume with only a small number of arbitrage orders.
Your second objective should be to make your arbitrage orders look less obvious to the broker and the liquidity provider. Your orders should not be easily identifiable as arbitrage orders. To that end, they should be open for longer periods of time, and they should aim at capturing more pips in terms of profits and not less (closing your orders after a profit of 1-2 pips will make it easier for the broker to flag your strategy). We have found a way to increase order duration and minimum profitability with the help of our lock arbitrage software and vip lock arbitrage software. This applications allows the trader to keep orders open for as long as several hours and to take money off the table only once a minimum number of pips have been captured (that minimum number can even be in the double digits). The software completely camouflages arbitrage trading. If you also add non-toxic orders to your trading flow, the results will be even better: not only will you be able to use arbitrage trading without giving your game away, but your business will also be more attractive to the broker, which will motivate the broker to protect your interests in case of a disagreement or a dispute with the liquidity provider.
To make it easy for traders to add non-toxic orders to their overall trading volume, we have developed a system that can be included with the VIP lock arbitrage product.
This system lets the trader create trading volume aimed at small profits or breakeven results, which in turn helps the broker earn more in commission fees, makes your trading very attractive to the broker, and helps camouflage your arbitrage strategy. We advise our clients to use this system in conjunction with the lock arbitrage software. This should help the trader use an arbitrage trading strategy with the same broker successfully for long periods of time.