At the heart of the free online trading software offering in the forex market lies the forex demo account, which has been carefully designed by the broker to draw you in for the sole purpose of opening an online trading account. Nothing wrong with that I hear you say, and I would agree, but let me explain why this seemingly innocent piece of trading software hides so many dark secrets, and in order to help you understand, we need to start at the centre of the web with the interbank liquidity pool. This liquidity pool is where the large central banks trade, with the ten largest controlling over 80% of the currency transactions executed each day, and I have listed these below. It is the trading between these banks that creates the foreign exchange rates which are then distributed to the various data feed providers.

  • Deutsche Bank  – 20 % fx market share
  • UBS – 12% fx market share
  • Citigroup – 11% fx market share
  • Barclay’s Capital – 7% fx market share
  • RBS – 7% fx market share
  • Goldman Sachs – 5% fx market share
  • HSBC – 5% fx market share
  • Bank of America – 4% fx market share
  • JP Morgan Chase – 4% fx market share
  • Merrill Lynch – 4% fx market share

Now from an online trading perspective as a small retail forex account, we have no access to the above market directly, and in many ways can be likened to the manufacturing industry, where goods are produced in large volume from raw materials, and then passed through a distribution system which may involve distributors and dealers, with the eventual item arriving in the retail shop for purchase by us, the consumer. The forex market can be viewed in this way, as it has many similarities, not least of which is the number of parties involved in getting the latest exchange rates to your online trading platform, but also in terms of the number of people who have taken their profit along the way. In the context of delivering a price feed of course, the profit for each party involves increasing the spread by a small amount, but with such huge online trading volumes each day, the banks and feed distributors make millions each day purely from delivering this data to the vast array of brokers and dealers with their proprietary trading platforms and brokerage accounts. The problem for us as forex traders is simple – the further we are removed from the interbank liquidity pool, then the more likely we are to be receiving delayed or manipulated price feeds, and here’s the reason why – it allows the broker to trade against us more easily using the free online trading software he so generously provided!

Forex brokers fall into four main categories, namely an ECN broker, am STP broker, an NDD broker and a Market Maker broker, and for the purposes of this explanation I propose to concentrate on the two extremes, the ECN broker and the Market maker broker.

  • ECN broker – an ECN ( Electronic Communications Network ) broker is one who passes all your trades direct into the interbank market, where they are matched with opposite trades. So if you are short, then the trade is matched with a long position, and visa versa, with the ECN broker acting as counter-party to the trade. The prices quoted by the ECN broker are extremely close to those prices being quoted in the interbank liquidity pool as the ECN broker makes his profit by charging you a commission on each trade, in much the same way as for traditional online share trading. As a result, the ECN broker provides accurate prices which truly reflect the underlying market in the interbank pool, and are not inflated or uplifted with an additional margin. In standing as a counter-party for your trades which are matched against other traders, all online trading is transparent, and as a result you trade against other market participants just as in the online futures market, and not against the broker. An ECN broker is recognised in simple terms by one that charges a commission on each trade, has a complex trading platform, and generally does not provide free online trading software or trading signals, other than a trading platform.
  • A Market Maker broker is the opposite of an ECN broker, and is the most common form of broker used by the retail forex trader. A Market maker actually makes a market for you, the trader, and as such you are therefore trading against the broker as a result. In order to make this easier for the broker, they provide you with a free online forex trading software for two reasons. Firstly the data feed they supply has their margin built in to the spreads quoted, which are generally fixed, and as such are often much worse than those quoted in the live market. Secondly, in providing you with a ‘free’ data feed, the broker is able to manipulate prices, freeze the screen or take out your stops when markets are volatile. Whilst the market maker broker will sometimes hedge your trade, generally they will take a position against you, as most brokers use the small clients as a contrarian indicator, since 90% lose.

This is how the forex market works at present and until the market is more tightly regulated, then these practices and others will continue unabated. There is too much money at stake for the market maker brokers to stop, and if you continue to trade using the free software tools that they probvide, then you are simply playing into their hands. Your free forex demo acount will not reflect any of the above issues, as this is their shop window to ensure you open an online trading account. However, as soon as you are a client, then you will expereience some or all of the above issues.

In addition to the above problems, there is also a further issue that the ‘free software’ debate raises, and this is to do with your forex trading strategy. Many Market Maker brokers will not allow you to undertake certain forex trading strategies such as scalping or hedging, as both strategies make it difficult for the market maker to trade against you and therefore make money easily. An ECN broker on the other hand has no interest in your online trading strategy as they make their money in commissions from your trades, and therefore generally allow all forms of online trading as a result.

So, as I said at the outest, there is no such thing as a free lunch, and in this case free forex trading software comes at a heavy price. It is not what is seems, and in using a free trading platform you are making it very easy for your broker to take your trading capital. If you do propose to use a free platform to trade, then make sure you subscribe to an independant charting package which will at least give you an indication of the price manipulation that your broker is employing each day, and may well shock you into closing your ‘free’ online account and changing to an ECN broker, with a professional trading platform, and no free charts. The money you invest in a good charting package and trading platform will be money well spent in the long run.