B-Book: How Do Forex Brokers Handle Risk?

When a retail forex broker takes the opposite of a customer's deal it has the option of either ACCEPTING or TRANSFERRING the market risk to another market participant.

When a broker agrees to accept market risk when a trade is been carried out is referred to as “B-Book execution”.

The act of taking the opposite of your transaction is called B-Booked execution.

Your line of work is often known as “B-Booked.”

Here are some more examples of industry lingo used to show that the broker has taken on risk:

· The threat has been “internalized” now.

· The threat has been “stored.”

Because the broker has decided to “keep” the risk, it has “internalized” it and “warehoused” it.

I'm not convinced market risk likes it when it's objectified.

Accepting market risk can be beneficial to the broker if the market swings in his favor or detrimental if the market swings against him.

Let's take a look at one of each.

B-Book Execution of the Order

Example #1: The Broker Comes Out on Top

Elsa went long 100,000 EUR/USD at 1.1500 in the example above. Her broker “B-Booked” (bet against) the trade and is now short 100,000 EUR/USD.

The pace of exchange of EUR/USD dropped to 1.1400.

Elsa can no longer handle it and sells 100,000 EUR/USD at 1.14000 to close her trade.

She loses $1,000 in the end.

P&L = (Exit Price - Entry Price) x Position Size

-1,000 = ((1.1400 - 1.1500) x 100,000)

The broker, on the other side, makes a $1,000 profit.

P&L = (Entry Price - Exit Price) x Position Size

1,000 = ((1.1500 - 1.1400) x 100,000)

The broker was rewarded with a PROFIT in this situation for accepting the market risk.

It was a successful outcome.

B-Book Order Execution

Example #2: Broker Losses

Now let's see what occurs when the market moves AGAINST the broker.

Elsa went long 100,000 EUR/USD at 1.1500 in the example above. Her broker “B-Booked” (bet against) the trade and is now short 100,000 EUR/USD.

The EUR/USD trades at 1.1700, up 200 pips.

Elsa chooses to take a profit and sells 100,000 EUR/USD at 1.17000 to close her trade.

She makes a $2,000 profit in the end.

P&L = (Exit Price - Entry Price) x Position Size

2,000 = ((1.1700 - 1.1500) x 100,000)

The broker, on the other hand, suffers a $2,000 loss.

P&L = (Entry Price - Exit Price) x Position Size

-2,000 = ((1.1500 - 1.1700) x 100,000)

The broker in this example lost money, which is the consequence of taking the market risk.

The outcome was unfavorable.

Here's how a B-Book broker makes money based on how a trade turns out:

Conflict of Interest Possibilities

The B-Book has sparked a lot of debate during its execution.

There is a potential conflict of interest because your broker gains money if you lose money.

It gives the broker the ability to do “evil” things in order to raise up the odds of your trades failing.

Traders are concerned about immorality of brokers who do not want their customers to be successful due to this.

Because the focus of this course is on how forex brokers manage their market risk, we won't dive into examples of broker shadiness just yet (not how shady brokers take advantage of their customers).

For the time being, just be aware that when a forex broker chooses to accept market risk (“B-Book execution”), there is a potential conflict of interest between the broker and its customers.

We'll talk about another way a broker controls market risk in the following lesson: by transferring it (also known as “A-Book execution”).