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Be Less Dumb – Avoiding Trading Traps Part 3
In my final look at trading traps I discuss the one topic everyone loves to complain about -- dealers.
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Unlike all the other markets in the world, FX is not centralized. That means there is no one single order book, no one arbiter of price. FX is a counterparty market which means that you are not really trading with the market at large but with your broker/dealer which acts as the intermediary to the market.
This arrangement is of course rife with conflict and the only reason it has survived and prospered is because competitions keeps everyone more or less honest. Nevertheless, sometimes I think more energy is spent on blaming the dealers than on trading the market. To those jaded amongst us it is no accident that those who sell drugs and FX are both called dealers. As I wrote in another weekly piece, “How many times do we see advertisements on the web enticing traders with ridiculous leverage offers of 100:1, 200:1, 300:1 even 500:1? The lure is incredibly tempting — turn $1000 into $100,000 within weeks! Take $10,000 and ride it to a million! Just like a drug high, a leverage high promises you perpetual bliss but in reality delivers mostly agony and pain. The truth of the matter is that in highly levered speculative markets it is far more common to see $100,000 accounts shrivel down to $1000 rather than the other way around.
Leverage just like drugs takes control out of your hands. The more leverage you use the more vulnerable you become. How many times have you been taken out of a trade that eventually recovered simply because you were over-leveraged? The margin call is the market’s secret weapon. It is the easiest way for the market to take away your money because it forces you to liquidate your position at the worst possible time, often at the absolute bottom if you are long or absolute top if you are short.”
So lesson number 1 in part 3 of this series is -- KNOW your dealers leverage and never use more than 20:1 at any given time. That does not mean that you can put on 5 positions at 20:1 lever factor each. It means that your total exposure should not exceed 20:1. So if you have 5 trades on at one time each should not be larger than 4:1.
Lesson number 2 -- Is your dealer Straight Through Processing (he sends the order directly to the Interbank Market with a mark-up to you) or is he Dealing Desk (he inventories your order in his own position book) STP dealers can be very good but their spreads can widen markedly during low liquidity hours. It is not unusual to see GBP/USD go 25 wide (that’s right 25 pips wide) between 5-6PM NY time. So if you hold positions during those hours beware.
Less number 3 -- ROLL!!! If you day trade there is absolutely no reason for you to hold a position past roll time (Usually 5 PM NY time but ask your dealer to be sure). Roll costs are totally unnecessary and can be as high as 5-8 pips on Wednesday’s when you have 3 days worth of interest due. This is a careless mistake that can easily be avoided.
Dealers are hardly angels, but some are much better than others. Here is a list of rules that I believe all reputable dealers should follow.
1. Allow you to withdraw money in NO MORE than 72 hours
2. Keep trading continuous and be able to absorb all orders of 500K or less without endless requotes
3. Execute your market orders within 5 seconds of entry.
If your dealer can’t provide even such basic service -- consider some alternatives.