Do Spreadex win if I lose?
Hi all, the team at Spreadex here today.
Something we always think is important is being transparent and providing an insight into how we operate, but also giving you a bit of an insight into how broking actually works.
There are many different ways in which brokers make money and operate (ECN, STP etc), but we will focus on how we work and what happens to your orders when you trade with us.
But firstly…
WE WANT OUR CLIENTS TO PAY SPREAD, NOT LOSE ALL THEIR MONEY
Yes, we are a spread betting & CFD firm which involves an element of taking the other side of an order, but we would much rather a client that trades fairly often and is likely to stay with us for the next 10 years versus one which we ‘B-book’, they lose their money and never trade again with us.
This is because our focus is on internalisation - that is we ‘cross up’ opposing client orders.
Let’s say we have someone buying the SSPX (the S&P 500 to you and I) - we’d not hedge it out because it’s a popular instrument and another client is likely to come on and sell an equal amount. By not hedging out ourselves, we save on hedging costs and can end up quoting tighter spreads, which is beneficial for the client.
The
GDAXI is a fantastic example of this, since we often have a better spread than the DAX futures market on EUREX (FDAX) itself!
To allow for internalisation though, we have risk limits for each individual instrument.
This means that if all of our clients want to buy theGDAXI at the same time, Spreadex’s risk limits will breach and Spreadex will also buy the GDAXI to hedge out its exposure. These risk limits are tighter for less liquid and less popular stocks – like UK small caps.
Having these risk limits means we are rarely running much directional risk in the market and are largely ‘delta neutral’ (see our post from last week for more on this).
Sure, we could make more money by trading against everything, but that carries its own risks too - if a left tail event* were to occur, it could blow us out of the water, so we’d much rather be more conservative in how we make money as a firm.
*A left tail event is something that leads to huge drawdowns but apparently only happens rarely.
A great paper on this by the New York Fed can be found here, in the context of currency markets.
‘On October 7, 1998, the
USDJPY exchange rate fell 11 percent. On March 7, 2002, the rate dropped over 3 percent. These moves, which dwarf the 0.7 percent standard deviation of daily returns in USDJPY since 1990, are symptomatic of a broader phenomenon: the well known "fat tails" of exchange rate returns. Since 1990, USDJPY returns above four standard deviations have occurred 85 times more frequently than predicted by the normal distribution; under a normal distribution, daily returns above 3 percent would occur fewer than once every 100 years.’
Since statistical models of how markets move are effectively broken, there’s clearly good reason for us to be cautious with how we manage risk and making money!
Something we always think is important is being transparent and providing an insight into how we operate, but also giving you a bit of an insight into how broking actually works.
There are many different ways in which brokers make money and operate (ECN, STP etc), but we will focus on how we work and what happens to your orders when you trade with us.
But firstly…
WE WANT OUR CLIENTS TO PAY SPREAD, NOT LOSE ALL THEIR MONEY
Yes, we are a spread betting & CFD firm which involves an element of taking the other side of an order, but we would much rather a client that trades fairly often and is likely to stay with us for the next 10 years versus one which we ‘B-book’, they lose their money and never trade again with us.
This is because our focus is on internalisation - that is we ‘cross up’ opposing client orders.
Let’s say we have someone buying the SSPX (the S&P 500 to you and I) - we’d not hedge it out because it’s a popular instrument and another client is likely to come on and sell an equal amount. By not hedging out ourselves, we save on hedging costs and can end up quoting tighter spreads, which is beneficial for the client.
The
GDAXI is a fantastic example of this, since we often have a better spread than the DAX futures market on EUREX (FDAX) itself!To allow for internalisation though, we have risk limits for each individual instrument.
This means that if all of our clients want to buy the
GDAXI at the same time, Spreadex’s risk limits will breach and Spreadex will also buy the GDAXI to hedge out its exposure. These risk limits are tighter for less liquid and less popular stocks – like UK small caps.Having these risk limits means we are rarely running much directional risk in the market and are largely ‘delta neutral’ (see our post from last week for more on this).
Sure, we could make more money by trading against everything, but that carries its own risks too - if a left tail event* were to occur, it could blow us out of the water, so we’d much rather be more conservative in how we make money as a firm.
*A left tail event is something that leads to huge drawdowns but apparently only happens rarely.
A great paper on this by the New York Fed can be found here, in the context of currency markets.
‘On October 7, 1998, the
USDJPY exchange rate fell 11 percent. On March 7, 2002, the rate dropped over 3 percent. These moves, which dwarf the 0.7 percent standard deviation of daily returns in USDJPY since 1990, are symptomatic of a broader phenomenon: the well known "fat tails" of exchange rate returns. Since 1990, USDJPY returns above four standard deviations have occurred 85 times more frequently than predicted by the normal distribution; under a normal distribution, daily returns above 3 percent would occur fewer than once every 100 years.’Since statistical models of how markets move are effectively broken, there’s clearly good reason for us to be cautious with how we manage risk and making money!
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