What is Price Shading? How You Can Take Advantage of This Common Broker Practice
A Guest Post By FXTM
What is price shading? Price shading is a practice that some forex brokers indulge in in order to better tilt the odds of success in their favor. Many traders don’t know about price shading but it is a common occurrence now among many brokers.
Forex prices move as a result of banks, hedge funds and institutions trading on the spot forex market via the interbank rate. To access these interbank rates requires a Reuters or Bloomberg Terminal and a significant amount of outlay which is why it is typically only the big players who have access to the tightest interbank rates.
Brokers on the other hand make money by buying or selling a currency at the interbank rate and offering it to a retail trader with a slightly wider spread. For example, if the interbank rate prices EURUSD at 1.3450-1.3451, the broker will offer 1.3449-1.3451, thereby offering a 3 pip spread and making one pip profit on either side.
Price shading comes into play when a broker manipulates their spread to one side of the market in order to better balance their books. When a large number of retail traders come in and take one side of the trade, the broker is more at risk on this one side. They therefore charge the retail trader slightly more on this side In order to offset their risk.
For example, if the majority of retail traders are buying EURUSD, the broker may increase the buy side of the spread to 1.3452 and take the sell side up a pip to 1.3450. In this way, the broker will make 2 pips for all the retail traders attempting to buy and will break even on those wanting to sell. The broker is therefore able to spread his risk more efficiently.
Taking advantage of price shading
While the practice of price shading may seem unscrupulous it is possible to use it to your advantage if you know when it is taking place.
When brokers indulge in price shading they typically make it more expensive for retail traders to trade on one side of the market. They also believe that when retail traders move to one side of the trade they usually wind up wrong.
Therefore, if you can find out when price shading is taking place, you will be able to understand which side of the market the broker favors. Trading on the brokers side is likely to be more profitable than trading on the side of the retail traders. And for another thing, trading with the broker means you are possibly getting a trade at near enough the same rate as the interbank spread.
Unfortunately, finding out when price shading is taking place can be difficult and it should not be confused with slippage – which causes spreads to widen during fast markets.
Setting up an account with a direct ECN broker or through a Bloomberg terminal and then comparing the interbank spread to the spread with your broker is one way that should enable you to discover price shading in action.