What is a Bucket Shop?
A Bucket Shop is a firm or company which operates as if it was a legitimate brokerage house dealing in certain financial instruments. When trading with a bucket shop however client trades are not passed onto the open market and there is no physical exchange of stock, commodities or any other financial instrument. Instead these firms take all client trades onto their own books, meaning that if a client loses they win and if a client wins they lose, which essentially makes the transaction a bet rather than a proper financial transaction.
Bucket Shops dealing in Stocks and Commodity Futures thrived in the US until the 1920’s when government action began to clamp down on them. These days the remaining Bucket Shops tend to operate from offshore secrecy centres, with Forex having become one of the primary product offerings.
FX Bucket Shops
As Forex is a global interbank market, the definition of what makes a brokerage a Bucket Shop is slightly different. For instance there are many legitimate brokerages operating as Market Makers who don’t necessarily place all client trades with a liquidity provider. These genuine Market Makers do however take certain measures to limit their own risk whether this is through the hedging of positions or by using their own risk management model.
A Bucket Shop operates differently and makes no effort to manage risk, simply taking client positions onto their own books and hoping that clients ultimately lose money. As the majority of retail Forex traders lose money, many of these rogue bucket shops are able to turn a considerable profit despite the fact that they expose themselves to a huge amount of risk. You will often find Bucket Shops adding in certain trading restrictions to ensure that they are more likely to come out winners in the long run, these instructions can include limiting scalping and news trading.
Traders should avoid Bucket Shops at all costs. The fact that the Bucket Shop is on the other side of the trade and will only make a profit if a customer loses means that the brokerage will often try and ensure the client loses. It is not unheard of for Bucket Shops to manipulate price feeds in their favour to ensure they come out as a winner in the long run. These and other tricks ensure that Bucket Shops are able to turn a profit consistently.
How to tell if a brokerage is Bucket Shop?
No brokerage will admit to being a Bucket Shop, which can make it more difficult to determine whether a brokerage is a Bucket Shop. Firstly, Bucket Shops tend to be unregulated or regulated in territories where there is little or no meaningful regulation covering the OTC products. This is partly why individuals should always stick to trading with firms regulated in a reputable jurisdiction. Before depositing with any brokerage it is important that individuals go out and do their research in order to find out what other traders are saying about a brokerage. If there is a lot of talk about a brokerage being a Bucket Shop it would be wise to proceed with considerable caution.
While an increasing number of brokerages are moving towards ECN/STP models, there are still a number of brokerages that operate as straight out Bucket Shops. It is recommended that traders avoid these brokerages as there is a clear conflict of interest with the brokerage only making a profit should the client lose money. Traders should undertake proper due diligence before depositing with a brokerage firm to ensure that they are both properly regulated and that they do not operate as a pure Bucket shop.