The common market conception about brokers is that when the trader wins, the broker incurs losses. Likewise, the broker generates profits when the trader runs into a loss.
Well, that's true for B-Book brokers or market makers. But remember, not all brokers operate like this.
In this lesson, you'll explore the concept of a B-Book broker and how it operates.
Lesson Highlights
- The core concept of B-Booking a trade is to keep trades in-house. By doing so, B-Book brokers take the opposite side of their clients’ trades.
- When a broker B-Book a trade, they gain as their clients lose. Likewise, they run at losses when their clients generate profits.
- B-Booking is a controversial type of forex execution due to possible conflicts of interest between traders and brokers.
What Is a B-Book Broker?
Okay, let's first review what a forex execution level is.
- The forex execution level represents where the broker executes their customer's trades. It may be on the actual market or an artificial market.
- A-Book brokers provide direct market access, wherein the customer's trade is directly executed in the market without any intervention.
- A-Book brokers offload the market risks of your trade to their respective liquidity providers.
But how about B-Book brokers? B-book brokers keep the trade in-house because they take the other side of your trade. This simply means they accept the full market risks associated with your trade.
What does that mean?
Here's Maria's trading situation to illustrate how B-Book trading works.
Maria executed a buy order for 100,000 units of EUR/USD at 1.1500, and her broker B-Booked her trade. Essentially, the broker accepted the market risk and took the counterparty side of the trade.
After some time, the EUR/USD experienced an upward trend, a 100-pip movement. So, she closed it immediately, and the realized a profit of $1,000 translated as her balance. Consequently, Maria's broker suffered a loss of $1,000 because it took the risks associated with Maria's trade.
Understood? Simply put, when your position gains $1,000, the broker loses $1,000, and vice versa. It's like how a seesaw operates
B-Book Broker and Risk Management
With Maria's situation, one may assume that brokers want their customers to lose while trading. While it would benefit them, a losing trader is not what they always wanted.
What B-Book brokers seek is a balanced ecosystem where their clients' trades offset each other.
You already know that B-Book brokers accept the risk of their customers' trades. So, they'll lose if their customer's position gains profits.
To counter this, B-Brokers prefer to have similarly sized customers who trade frequently and open positions that offset one another.
For example, 50% of Broker X's customers open a long position, and the other 50% open a short position. If all trades are of the same value, then the risks associated effectively cancel each other out.
To put it into perspective, here's the situation of B-Book broker X:
Broker X is a B-Book broker with 100 clients actively trading in EUR/USD. Luckily for the broker, half of the traders went long, while the other half opted for a short position.
After a few minutes, the EUR strengthens against the USD, making the EUR/USD rise in value. This means that 50% of Broker X customers who went long EUR/USD made a profit. Considering the broker accepted the market risks by B-Booking all its customers' trades, Broker X incurred losses because 50 of its clients made a profit.
However, since 50 of the clients decided to go short on EUR/USD, Broker X also gained profits due to the losses of short-positioned clients. As a result, the profits Broker X made on one group of traders offset the losses incurred on the other group.
In this scenario, Broker X effectively manages the risk exposure caused by B-Booking its clients' trades.
How Does a B-Book Broker Make Money?
B-Book brokers are infamously known for taking the opposite side of the clients' trade. With that, they're known to profit from their clients' losses.
However, as shown in Broker X's perspective, B-Book brokers are not essentially rooting for their clients to lose. They simply want an equal number of traders that offset each other's trade.
The primary revenue stream for B-Book brokers is either through spread or commission.
1. Spread Markup
The primary source of revenue for B-Book brokers is the spread, which is the difference between the asset's bid (selling) price and the ask (buying) price.
When clients execute trades, they do so at prices slightly different from the market, and this price difference contributes to the broker's revenue.
Assume you're a retail seller. You sell your products at a retail price, but you purchase the said product at a wholesale price. This way, you profit from every transaction because of the price markup.
2. Commission
B-Book brokers may charge commissions on trades executed by their clients.
But remember, the commission fee structure for each broker varies. You may see a broker that imposes a commission fee per lot, per million traded, or per trading frequency.
Risk of Trading B-Book
Traders view brokers as intermediaries between them and the forex market. However, by B-booking the trade, brokers become the counterparties of their customers' trades.
This could result in a conflict of interest between the two parties, a common controversy with B-Book execution.
Knowing that the B-Book brokers are market makers, they control the market movement. This creates the opportunity for brokers to manipulate the market and make your position lose.
