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What is A book and B book in forex trading?

ledgerWhat’s in book, you might ask? Well, no matter what market you trade, fact is that for most investors and traders, you can only get access to the financial market through your broker. Your broker, in turn has an option to execute your trade in one of the many ways.

Books, in trading are commonly used in order to mitigate risk. The term book is similar to a book used in accounting, such as ledger. The ledger keeps tracks of the cashflow. An accountant, in most cases has the ask of ensuring that the books are always balanced.

The term balanced simply means that the assets and the liabilities always match up.

In trading terminology, books are no different. Thus, a brokerage or a hedge fund, or even an investment for that matter maintain a number of books. High risk assets are often clubbed into one book, while other assets are clubbed into a different book.

From a forex terminology, A book and B book are mostly commonly used terms.

 


What is an A book?

An A book is a term or rather a book or a portfolio where the trades are executed STP (straight through processing) and directly onto the prime brokerage. In an A-Book, your trades are untouched and executed against the liquidity pool.

In brokerage terms, one can draw parallels to an A book as an ECN (electronic communication network) type of execution.

There are of course advantages and disadvantages. For one, with an A-book, you are most likely to encounter variable spreads. Chances are that in most cases, the broker will also add a market up to these spreads, on top of charging you commissions.

In an ECN model or an A-book, brokerages charge you a commission for a round trip lot. This means that every time you open and close a trade, a commission is charged. Most brokers tout this as a better way to trade and take advantage of the misconceptions of a market maker model.

The point to understand is that with an A-book your order is executed only if it is matched with a counterparty buyer or a seller. When your order doesn’t match, chances are that it will either remain open or you will be matched at the best price available (which might not always be the price you wanted).


What is a B book?

A B-book on the other hand is a portfolio or a book where trades are matched in-house. Think of the B-book as a market maker model. There is a lot of misconception about B-book, also known as B-booking. This is the market maker model and the general prevailing notion is that the brokerage trades against you.

In fact, if you read a lot of articles, you will come across texts such as the broker taking opposite positions against you. This is incorrect. In a B-book, the broker’s main goal is to act as a market maker. A forex broker does not simply take a position against you and wait for you to lose.

Rather, once a forex broker takes a counter position against you in the B-book, it is often offset or passed over to another trader. Of course, the brokerage makes money by passing on your order to another trader at a different price, which is where they make money.


The conflict of interest

 

A Book B Book

A Book/B Book Execution

 

When we talk about the A and B books, the term, conflict of interest stands out quite instantly. In a B-book, the conflict of interest is clearly seen. The broker, because they act as a market maker can see the price at which you are buying or selling.

At the same time, they know the price at which they need to sell or buy to offset your risk onto another trader. This may be good or bad, depending on how you see it. It also brings about the question of whether it is good to trade with a market maker or with a straight through processing (STP) broker.

Under normal circumstances, it might seem like a good bet to go with an A-book broker. Afterall, it is good for you to have your orders being executed with the prime brokerage and in the liquidity pool right?

But that is not often the case. When the liquidity pool dries up, chances are that you will be the one left holding the bag. There are numerous examples of how market makers are essential to the sound functioning of the financial markets.

As a trader, whether it is an A-book or a B-book, you really shouldn’t bother. What you need to consider are the costs. Because a B-book will most often quote you fixed spreads, you need to figure out if the fixed spread is worth paying for.

On the other hand, if you prefer an A-book, then you need to ask yourself the question if you are willing to trade with wider spreads during times of market volatility or risk not having your order filled during immense economic shocks.

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