September 22

Building a Superior OTC Foreign Exchange (FX) Broker

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Since the credit crunch began in 2008, there has been a very large move of capital into trading the OTC FX markets from equities and futures. Regulation and mature, exchange-traded markets have pushed profitability to very small margins in futures and equities markets for FCMs, brokers and traders alike. As a result we are seeing a strong movement to not only trade the OTC FX markets, but also capitalize on the demand by opening OTC FX brokerages. By nature, the FX markets have shown a unique ability to cross funge and trade between different liquidity providers and various pricing streams that allow sophisticated algo, or rules-based traders to arbitrage basic currency pairs with very little cost overhead. As a consultant and technology provider to many FX traders and brokers FCM360 has seen a proven method of building an FX broker that can attract sophisticated traders with large deposits.

The three components to the method are: 1 – LIQUIDITY 2 – COLOCATION HOSTING AND CROSS CONNECTS 3 – RISK MANAGEMENT

Liquidity is a very strange thing, every time we speak to a trader they say that the new broker they are trading with claims to have the best liquidity but almost all of them are disappointed in executions, time to fill and last look issues creating tremendous slippage. Liquidity comes down to one thing: Relationships with liquidity providers. The best liquidity comes with relationships the brokers or traders have with the liquidity providers. You can be a small broker dealing with a large bank or liquidity provider and provide excellent liquidity to your clients, if the relationship is right. There are many pricing feeds and apis available to brokers and traders but they are not created equal. Make sure you have a real relationship with your liquidity provider before assuming it will be the best just because they say they do.

A new infrastructure trend appeared throughout 2011 that required most brokers, traders or liquidity aggregators to cross connect to the liquidity provider in key buildings located in New York and London. These building are specifically Equinix NY2/4 and LD4/5. In the beginning of 2011 a small number of banks and liquidity providers actually had a forex exchange presence in Equinix. By the end of 2012, nearly all major bank liquidity providers had some sort of presence in these buildings through their own cages or working through managed hosting providers to establish presence and enable clients and counterparties to cross connect to them. The term, “cross connect” has became one of the biggest buzz words in the FX business.  If you want traders and liquidity providers alike to take you seriously, you must be able to cross connect to them. If you cannot cross connect, you will spend exponentially more money bringing private lines into their datacenter point of presence.

Risk management is an essential part of every FX broker business. Risk management is not only about protecting your business, it should also be able increasing profitability. At the core of the risk management strategy, your firm should be actively hedging risk, monitoring aggregate client exposure 24/7, looking for early warning signs of predatory trading along with API and expert advisor abuse if you run a platform like Metatrader. If you are not doing these key tasks, consider hiring a specialized company to do this for you. We have seen brokers lose millions of dollars in a day due to system errors. This is money you will not get back.


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