Choosing a broker: neutral vs. non-neutral
What kind of brokers exist in the trading world, and can you trust a provider whose financial interest is the opposite of your own? In this blog, we’ll break down the difference between the traditional market-maker model and market-neutral trading.
When you’re looking to trade financial markets, whether it’s forex, stocks or commodities, you will almost always need a broker to execute your orders.
There are essentially two kinds of broker.
The non-neutral (traditional) broker
The first kind, which we will call ‘the traditional broker’ or market maker, carries a market risk on your positions. This means you are effectively trading against them on how the market will perform.
If a broker is the counterparty to your trade and does not offset their exposure (or only offsets part of their exposure), their own return depends on the performance of the market. They basically stand to make a better profit if you lose, and vice versa.
This is non-neutrality, and can represent a conflict of interest in the client-broker relationship.
The market-neutral broker
We can call the market-neutral broker ‘the non-traditional broker’. This type of broker will never be on the other side of your trade.
A market-neutral broker will have automated processes that do not require a dealing desk. So, instead of making money when you lose, they only make money on the spread (or fee) that they charge each time you make a trade.
This broker automatically mirrors your trade in full in the underlying market, and therefore offsets any risk of running up losses if all its clients make winning trades. In other words, they never have a desire to see you lose, since their profit never depends on your loss.
Unlike a dealing desk, a neutral broker therefore has a vested interest in providing the best possible trading service to assist its clients to trade.
Choosing a broker
Though any legitimate broker will be open about their methods of operation, and should be receptive to your questions as a client or prospective client, the idea that non-neutral brokers may at times have a vested interest in whether your position makes a profit could be a turn-off to many traders.
Market-neutral brokers, on the other hand, offer a direct and transparent way to trade with no conflict of interest.
This isn’t to say neutrality is the sole characteristic that should determine which broker you choose. Fees, spreads, customer service, software, market access and trading apps are all factors to be weighed. Whether or not a broker is market-neutral, and whether or not that matters to you personally, is just one more factor to consider.
You should under no circumstances consider the information and comments provided as an offer or solicitation to invest. This is not investment advice. The information provided is believed to be accurate at the date the information is produced.