Lesson 5: How Forex Brokers Use Hybrid Execution Model

In the previous lessons, you've learned the different execution models that brokers use to manage risk and, for some, make more money.  

Let's review,

1. A-Book Execution: This is where your broker directly routes your trade to the liquidity provider (LP). It can also take the opposite of your trade but offset the risk by opening a similar trade with its LP.  
2. B-Book Execution: This is where your broker becomes the counterparty of your trade. Essentially, it will run at a loss if your trade gains because it accepts the entire market risks of your position.  
3. C-Book Execution: This is where your broker tweaks the A-Book and B-Book to make more money out of your trade. It can partial-hedge, over-hedge, or reverse-hedge your trade.  

In this lesson, you'll learn how a broker uses either of these execution models to make the most out of your position.  

Lesson Highlights

• A-booking, B-booking, and C-booking are the primary execution models that guide broker operations. Hybrid brokers use all three models.
• A hybrid broker profiles its clients to know which type of execution model would yield high returns for their business.

Execution Model and Forex Brokers 

Traditionally, traders see financial brokers as intermediaries between them and the market. But there are now different approaches to guide brokers' operations. 

Execution models are the methods your forex brokers use when handling and executing your trade order. Simply put, this shows whether your broker routes your trade to the market, internalizes it, or hedges it to the LP.  

Here are the two common execution levels used by forex brokers: 

1. Straight Through Processing (STP): When a broker uses the STP model, the broker acts as an intermediary between the traders and the network of liquidity providers.  
2. Dealing Desk (DD): When a broker uses a DD model, it takes the counterparty position of your trade. 

Forex brokers are not restricted to using only one execution model when filling in your trade order. Most brokers you encounter will likely operate at least both A-Book and B-Book trading. 

How Forex Brokers Execute Hybrid Model 

When your broker uses a hybrid method to execute your trade, they can do the following simultaneously; 

1. Offset the market risks among its customers by matching trades with the same currency pairs and value 
2. Offload the market risk with the LP and simply generate profit through price markup and commission 
3. Fully accept the market risk and be a counterparty of the trade.  

The common practice of brokers is to divide their customers, hedging the trades of some customers to the LP (A-Booking) while keeping the remaining orders in-house.  

To paint a better picture, here's how Broker X uses a hybrid method to profit more from its customers' orders.  

Sample Scenario 

Broker X is a brokerage firm with 100 active forex traders. It knows 65 of its traders are profitable, so Broker X A-Booked their traders. It offloads the market risks by mirroring their trade and executes the mirrored trades with the liquidity providers.  

Meanwhile, the 35 remaining traders usually make uninformed trading decisions. What it did was to keep these orders in-house to profit once the customer lost the trade.  

This way, the broker maximizes all its potential profits while managing the risk.  

The question is, how do they know if the trader is profitable? Well, it follows systematic practices to ensure that the broker is not putting itself at risk. 

Customer Profiling 

When a hybrid broker divides its customers, it must decide which ones will be A-Booked and which trades will be B-Booked.  

What they do is check the past trading activities of the trader and see whether the said trader tends to win trades or not. If not, it will likely be kept in-house; if yes, it will be hedged.  

And remember, the broker doesn't do the selection manually. It normally develops a technology that automatically routes orders to A-Book and B-Book execution based on a certain parameter.   

Throughout this module, you’ve learned the different execution models that brokers use to manage risk and generate more profits.

For the next module, you’ll be introduced to MetaTrader 4—the most popular trading platform in the financial market.