Stock firm enters forex business

While the spot forex market continues to grow, it is still an area many on the stock side of the business are hesitant to enter.

However, direct-access firm MB Trading is trying to change that by creating a currency ECN. Equity ECNs (Electronic Communications Networks) such as Archipelago and Island revolutionized stock trading in the late 90s by allowing traders to bypass the exchanges and execute trades almost instantaneously.

Steve Demarest, co-founder of MB Trading, says he didn’t think much of the forex ECN idea when he first heard about it. However, he kept hearing more about the foreign exchange market and decided to take the idea seriously.

“When I started digging into it and learning about how the business works, I saw an obvious opportunity that I could build a better product based on the technology I already had for stocks, options, and futures,” Demarest says. “It was an easy fit — I have the technology. I just have to write the logic for forex, but I can use the same infrastructure I currently have.”

Stock ECNs work by aggregating trades into an order book, then executing trades from that book. The currency ECN will work slightly differently, as MB, which registered as a Futures Commission Merchant (FCM), has agreements with 11 banks that will offer liquidity on both sides of trades.

“Most FCMs take the other side of the trade, so if the customer wants to buy the Euro/dollar, the FCM sells it to them, which makes the FCM short,” Demarest says. “It’s obvious to me that your interests and the interest of the FCM aren’t aligned. Essentially, they are betting against you.

“But in our system, if a customer wants to buy the Euro/dollar, we take the order and pass it through to the banks. So we are not taking the other side, and we are not trying to manipulate the market to our advantage. Because our interests are aligned with the customer, we try to get them the best price available.”

The banks are willing to participate because MB will provide them with liquidity.

“These banks would still trade without us,” Demarest says. “But they are going to get long or short in certain currencies, and they will try to mitigate their open positions.

That’s why some banks will have tighter quotes than others, and they are looking for someone like us to allow them to get in or out of positions. That’s the benefit to them. The benefit to our customers is that they get a better price than they would with a traditional FCM.”

The concept of a currency ECN is not a new idea. However, few firms have found success with the concept and have adjusted their business models.

Demarest believes MB Trading’s experience with stock ECNs gives them an advantage over previous currency ECN start-ups, who may not have been entirely familiar with how the technology works.

Much of MB’s technology was built by the same person who was instrumental in building Archipelago’s technology, and Demarest thinks he can add new features to the ECN that will differentiate it from previous models.

“I’m not sure [other companies] understood nearly as well as us how a good ECN should work,” he says. “It’s the features of that ECN that will give us traction and allow us to work a little better.”

Nonetheless, stock ECNs were successful because there was a large pool of stock traders waiting for something to make their lives easier. While the number of forex traders in the U.S. is growing, it pales in comparison to the stock trading population in the late 90s.

However, Demarest blames that on a lack of available tools and technology for forex traders. He thinks a product such as a currency ECN will spark considerable interest in the foreign currency market.

“Right now, there is so much more opportunity for a trader to make money in forex than there has been for quite a while in the equities market,” Demarest says. “When the tools are finished, I think you’ll see a huge migration of equity traders go into forex. The pool is the same pool, but you’ll see them start trading forex in addition to equities.”