Three Market Myths Debunked

FX:EURUSD   Euro / U.S. Dollar
There's a tonne of myths out there to do with markets and trading, some which are totally bullshit and others which are half truths, embellished to their fullest.

We're going to take a look at some of these and see what the real story is behind these tales.

The myth about free trading apps

You've probably seen adverts recently for free trading apps or brokers.

You know the ones...

Robinhood in the US is the best example of this.

But are they really free?

Not really.

See, it's a marketing trick.

No, there aren't any explicit commissions added, but they make money by a practice known as payment for order flow.

What's that?

This is the compensation received by brokers for directing trading flow to different counterparties to fill the trade.

High frequency trading firms such as Virtu and Citadel tend to be the largest beneficiaries of Robinhood's flow.

Payment for orderflow is 'banned' in the UK under MiFID...

But I'm not so sure it's not being carried out.

Here's what IBKR (Interactive Brokers Lite) say in their best execution policy.

New and existing clients will be able to select between using IBKR Lite and IBKR Pro and switch between the two levels of service up to three times and then once per quarter. Like many other brokers, Interactive Brokers will route the orders of IBKR Lite clients to market makers in exchange for receiving payment for order flow. Clients that opt to use IBKR Pro will continue to receive the best prices our sophisticated algorithms can secure for them.

Yes, this is mainly US focused because PFOF is banned in the UK, but perhaps what is going on in the UK every now and then is that flow routed to an overseas subsidiary (usually US based) to get around the issues (I doubt it though, so US readers, this is focused to you).

What this tends to mean is that uninformed traders are drawn in by the marketing, and who will be more price agnostic.

They will be happy to filled at a worse price than the shown bid or offer.

This is profitable for the market making firm.

When it comes to fractional share dealing in the UK, you are being filled in house predominantly and the broker takes the spread.

Fractional share dealing is naturally an indicator of an unsophisticated market participant, so they're happy to run with this model - it probably works well for both parties, actually.

To achieve the best pricing, the tip then is to be well capitalised and to choose your broker carefully.

And not to YOLO long deep OTM calls with full leverage.

The myth about market makers

My favourite.

If you haven't watched this interview that I did with Adam Webb, then you're missing out.

Market makers are not out to get you.

They couldn't care less about your stops.

They are there to provide liquidity to a market and want to remain delta neutral - that is, their inventory at the end of the day is neither up nor down but flat.

What most people might think that a market maker does (and they would be right, but not necessarily in the traditional sense) is run a B-Book where all flow is internalised.

Retail brokers might do this because they know that most people will lose.

And a handful might run a plugin such as MT4 virtual dealer which messes with order execution and limits positive slippage, but for the most part, brokers on the other end of your trade will monetise the flow that they can - and if this means not putting your order through to the actual market (at no detriment to you - the B Book can mean you get better fills sometimes) then so be it.

The myth about ECN/ STP brokers

This is a big one in my view.

A few years ago, there was a load of furore surrounding wanting to be with a true ECN.

Firms advertised that they were an ECN (electronic communications network)/ STP (straight through processing) all over the place.

Both of these terms essentially mean that you're being filled by a liquidity provider who is connected to prime brokers.

The problem is that many were simply sending flow to a different legal entity and B-Booking them there.

If you recall, FXCM was banned from the US for doing pretty much this.

You can check out where the percentage of orders are executed by looking at a firm's RTS-28 disclosure - give it a Google .

Again, just do due diligence.

Ask around your peers, and make sure you pose questions to the broker.
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