Price shading is often used by the brokers at a time when they think of the price of a currency is on a rising trend. Here in the case, the broker chooses to add pip or two to the currency quote. This helps the broker to take advantage of the customers. To practice the concept of price shading, it is very important to do background checks on the forex spot market which is an interbank market. Banks trade with each other and trade the prices. These prices are created in accordance with bids and offers of most liquid banks in any single specific currency. This trading can’t be regulated or available in a formal exchange like the stock market.
The prices of the interbank currencies are displayed as stream prices on the terminals lie Bloomberg. These prices are majorly used to trade with hedge funds, banks and traders. This is usually used to gain an advantage over the customers by adjusting the prices.
The main question in your mind must be “ How to practice this?” Being a broker, you will get a series of prices from the banks for which they will have accounts and then they will fix prices based on the aggregation of prices received. Then these prices are offered to the customers after adding their own margin. Just for instance, if they receive a price of 51 – 53 for 41 while trading in euro, this shows that the bank would probably sell it for $ 1.4153 or buy it at $ 1.4151. Therefore if a broker wants to offer this trade to a customer, he would add his own margin and probably sell it for $ 1.4154 which is a three-point spread.
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As the order flow comes from the retail customer, they tend to get wrong, hence the broker has to adjust the offer to charge a bit more from all the buyers. Therefore if a buyer pays more, a broker can increase his profit. The broker usually believes that the market will sell off and would accept the risk of shading the spread.
Let take that there are 100 sellers and 100 buyers, the broker is going to one pip from each trade. Hence there are going to be 200 pips in total. But if there are 50 sellers and 150 buyers and no profits for the sellers. This would lead to 300 pips of profit. This allows the brokers to move higher on the buy-side of the interbank rates consistently.
Price shading does not always have a total negative part for the traders. But if you see a broker’s pricing is very consistent on one side, it happens due to the creation of order flow imbalance. The majority of the traders are wrong about price shading. There could be a chance to trade against the bias by selling, or by buying if bias is on the sell-side. The broker must move the spread to disadvantage for the sellers who would be able to enter the positions at good prices if the broker doesn’t shade.
When it comes here, the best way to go ahead is to make your research up to date. Understand the commission structures of the brokers and how they are paid. Find a broker to make you profit, and practice’s transparent business.
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