Risk management is often perceived as mysterious and
mystifying but an endeavour that must succeed for the good of the business. The
necessity will always be true, but the perception shouldn’t be true at all. Whether it be trading industry insiders, financial market
participants, or even the financially unsavvy, most have a vague perception of
risk and, typically, as a costly afterthought.
In retail trading, dealing desks are entrusted to
risk-manage the firm’s solvency – assuming they do not rely on “magic” to
conjure results. When it all doesn’t go to plan, dire consequences follow. In 2015, dozens of millions were lost in seconds when the
world’s third-largest retail broker – Alpari (UK) –
mismanaged its market and counterparty risk during a sudden bout of Swiss franc
currency intervention.
The same wave affected several other brokers, including FXCM, the world’s largest
at the time, while other firms, such as Effex Capital and Boston Prime, faced
similar challenges. They all learned the hard way that risk management is where
brokers should start, not finish.
Dealing has always been at the core of broking, with faulty
offerings incurring significant financial losses. Yet, rumours continuously
circulate that several brokers are within touching distance of a single large
client causing irrevocable damage to their solvency.
In today’s markets, many brokers invest significant
resources to demystify order flow management while inventing quirky new
concepts like C-book and Value at Risk variations to empower their
dealing teams. Ultimately, retail and institutional dealing desks are
somewhat different despite doing the same thing.
Institutional dealing desks are usually stuffed with
quantitative professionals with mathematics, engineering and programming
backgrounds. Such individuals are required to construct highly complex models
in Python and R.
In contrast, retail brokers typically employ individuals
with market awareness yet lack the statistical and mathematical acumen to
mitigate market risks from magnifying losses on their order books. In modern
markets, a lack of statistical sophistication or a sloppy algorithm will
ultimately lead to suboptimal performance and, more than likely, capital
haemorrhage. Frequently, retail brokers mistakenly think they can outmanoeuvre
market counterparties by predicting random flows or by keeping faith in the client’s
propensity to make the wrong moves.
Simply Retail
Traditionally, a retail dealing desk operates on what is
known as a “B-book” model. With a B-book, the broker assumes all the risk from its
retail clients, meaning that clients trade directly against the broker. This
model isn’t inherently unviable because even if the broker A-book’s the trade
and offloads it to the market, it just means another counterparty will
warehouse the risk, effectively turning one broker’s A-book into another’s
B-book.
Specifically, the broker must accurately price trades,
execute them with the best available prices, handle slippage in low liquidity
markets, and replicate actual market conditions. Always using multiple
Liquidity Providers (LPs) is crucial, and the dealing desk must always stay sharp to avoid delays. Specific instruments may have
preferential sources compared to others, which requires regular monitoring.
Meanwhile, bonus campaigns should be carefully structured to
prevent arbitrage in all market conditions. As markets get savvier, so do
traders, which means any bonus-offer vulnerability will be quickly exploited.
One solution is for dealing desks to incorporate Key Performance Indicators
into their modus operandi to take the focus away from periodic profit
and loss. Ideally, unlike the current status quo, the desk should
operate a liquidity bridge to offset various orders to the broader market.
🔍 StakeWise is reimagining liquid staking.
We sat down with Kirill Kutakov, co-founder of @stakewise_io, to discuss their innovative approach, risk management strategies, and what the future holds for the protocol. Dive in for an exclusive insight👇https://t.co/TnXvbUXAIj
— IntoTheBlock (@intotheblock) April 3, 2024
Institutionally Intricate
Institutional risk management is an entirely different
animal from retail – the level of complexity is much higher, and so are the
stakes. The moment a dealing desk misses crucial real-time
information, they become instant arbitrage targets. Whether related to swaps,
mark-up mispricing, partially hedged positions, or delays – any opening in the
firm’s defences leaves it vulnerable to significant losses.
A different approach is required compared to the traditional
management of retail flows. Typically, institutional desks hold risk for short
periods or within specific timeframes before offloading it. Their teams are typically staffed by quants, many holding
PhDs from prestigious universities.
They possess a deep understanding of
various API feeds used by institutions. Employing logarithmic modelling, they
scrutinise orders for potential arbitrage, lodging complaints with the offering
party when discrepancies are identified. Quants are proficient programmers and
maintain ECNs with price feeds from top-tier and second-tier institutions.
Sometimes, they engage in flow arbitrage as far as the LPs allow them.
Depending on the service, they may adjust prices and discuss
progressive concepts such as “last look” orders – a time-limited ability for
LPs to reject an order. Some, but by no means all, utilise this feature as part
of their usual operations. Additionally, highly quantitative teams have
specific holding time preferences, such as maintaining Eurodollar positions for
some prefix timeframes. The machinations of an institutional dealing desk can
cascade down the pecking order to wreak havoc on a retail broker.
A lot of TRADERS out there are asking how to gain confidence
But tell them to take Trades, they are scared
Tell them to Practice ther Strategy. They are lazy to do that
Tell them to maintain solid Risk Management and they have a Blow it all mentality
Tell me how do you…
— E – FOR3X (@EForex01) April 2, 2024
Unify or Multiply
In all the years I spent on dealing desks, a question that
always lingered with me was: is it better to operate one unified dealing desk
covering both retail and institutional flow or to create two teams, each with a
dedicated focus?For a long time, I was convinced that two teams were the
optimal choice. However, given the rapid development and deployment of fintech,
the game has changed. Today, with the right tools, the proper training, and a
rethink about what roles are needed in dealing, I firmly believe that one
unified team is the best way to go.
For the first time in history, cost-effective brokers can
use tech-powered and data-driven strategies to streamline their risk management
and, thereby, emulate the operational prowess of their institutional peers. Instead of perpetuating a perception of mystification and
mysteriousness, dealing desks should come out of the wilderness by leading from
the front with progressive risk management that truly de-risks their
operations.
Risk management is often perceived as mysterious and
mystifying but an endeavour that must succeed for the good of the business. The
necessity will always be true, but the perception shouldn’t be true at all. Whether it be trading industry insiders, financial market
participants, or even the financially unsavvy, most have a vague perception of
risk and, typically, as a costly afterthought.
In retail trading, dealing desks are entrusted to
risk-manage the firm’s solvency – assuming they do not rely on “magic” to
conjure results. When it all doesn’t go to plan, dire consequences follow. In 2015, dozens of millions were lost in seconds when the
world’s third-largest retail broker – Alpari (UK) –
mismanaged its market and counterparty risk during a sudden bout of Swiss franc
currency intervention.
The same wave affected several other brokers, including FXCM, the world’s largest
at the time, while other firms, such as Effex Capital and Boston Prime, faced
similar challenges. They all learned the hard way that risk management is where
brokers should start, not finish.
Dealing has always been at the core of broking, with faulty
offerings incurring significant financial losses. Yet, rumours continuously
circulate that several brokers are within touching distance of a single large
client causing irrevocable damage to their solvency.
In today’s markets, many brokers invest significant
resources to demystify order flow management while inventing quirky new
concepts like C-book and Value at Risk variations to empower their
dealing teams. Ultimately, retail and institutional dealing desks are
somewhat different despite doing the same thing.
Institutional dealing desks are usually stuffed with
quantitative professionals with mathematics, engineering and programming
backgrounds. Such individuals are required to construct highly complex models
in Python and R.
In contrast, retail brokers typically employ individuals
with market awareness yet lack the statistical and mathematical acumen to
mitigate market risks from magnifying losses on their order books. In modern
markets, a lack of statistical sophistication or a sloppy algorithm will
ultimately lead to suboptimal performance and, more than likely, capital
haemorrhage. Frequently, retail brokers mistakenly think they can outmanoeuvre
market counterparties by predicting random flows or by keeping faith in the client’s
propensity to make the wrong moves.
Simply Retail
Traditionally, a retail dealing desk operates on what is
known as a “B-book” model. With a B-book, the broker assumes all the risk from its
retail clients, meaning that clients trade directly against the broker. This
model isn’t inherently unviable because even if the broker A-book’s the trade
and offloads it to the market, it just means another counterparty will
warehouse the risk, effectively turning one broker’s A-book into another’s
B-book.
Specifically, the broker must accurately price trades,
execute them with the best available prices, handle slippage in low liquidity
markets, and replicate actual market conditions. Always using multiple
Liquidity Providers (LPs) is crucial, and the dealing desk must always stay sharp to avoid delays. Specific instruments may have
preferential sources compared to others, which requires regular monitoring.
Meanwhile, bonus campaigns should be carefully structured to
prevent arbitrage in all market conditions. As markets get savvier, so do
traders, which means any bonus-offer vulnerability will be quickly exploited.
One solution is for dealing desks to incorporate Key Performance Indicators
into their modus operandi to take the focus away from periodic profit
and loss. Ideally, unlike the current status quo, the desk should
operate a liquidity bridge to offset various orders to the broader market.
🔍 StakeWise is reimagining liquid staking.
We sat down with Kirill Kutakov, co-founder of @stakewise_io, to discuss their innovative approach, risk management strategies, and what the future holds for the protocol. Dive in for an exclusive insight👇https://t.co/TnXvbUXAIj
— IntoTheBlock (@intotheblock) April 3, 2024
Institutionally Intricate
Institutional risk management is an entirely different
animal from retail – the level of complexity is much higher, and so are the
stakes. The moment a dealing desk misses crucial real-time
information, they become instant arbitrage targets. Whether related to swaps,
mark-up mispricing, partially hedged positions, or delays – any opening in the
firm’s defences leaves it vulnerable to significant losses.
A different approach is required compared to the traditional
management of retail flows. Typically, institutional desks hold risk for short
periods or within specific timeframes before offloading it. Their teams are typically staffed by quants, many holding
PhDs from prestigious universities.
They possess a deep understanding of
various API feeds used by institutions. Employing logarithmic modelling, they
scrutinise orders for potential arbitrage, lodging complaints with the offering
party when discrepancies are identified. Quants are proficient programmers and
maintain ECNs with price feeds from top-tier and second-tier institutions.
Sometimes, they engage in flow arbitrage as far as the LPs allow them.
Depending on the service, they may adjust prices and discuss
progressive concepts such as “last look” orders – a time-limited ability for
LPs to reject an order. Some, but by no means all, utilise this feature as part
of their usual operations. Additionally, highly quantitative teams have
specific holding time preferences, such as maintaining Eurodollar positions for
some prefix timeframes. The machinations of an institutional dealing desk can
cascade down the pecking order to wreak havoc on a retail broker.
A lot of TRADERS out there are asking how to gain confidence
But tell them to take Trades, they are scared
Tell them to Practice ther Strategy. They are lazy to do that
Tell them to maintain solid Risk Management and they have a Blow it all mentality
Tell me how do you…
— E – FOR3X (@EForex01) April 2, 2024
Unify or Multiply
In all the years I spent on dealing desks, a question that
always lingered with me was: is it better to operate one unified dealing desk
covering both retail and institutional flow or to create two teams, each with a
dedicated focus?For a long time, I was convinced that two teams were the
optimal choice. However, given the rapid development and deployment of fintech,
the game has changed. Today, with the right tools, the proper training, and a
rethink about what roles are needed in dealing, I firmly believe that one
unified team is the best way to go.
For the first time in history, cost-effective brokers can
use tech-powered and data-driven strategies to streamline their risk management
and, thereby, emulate the operational prowess of their institutional peers. Instead of perpetuating a perception of mystification and
mysteriousness, dealing desks should come out of the wilderness by leading from
the front with progressive risk management that truly de-risks their
operations.
