What is "Price Shading" on trading platforms?

Price Shading

Price Shading is a practice used by some forex brokers who add a pip or two to the price quotes of a currency pair depending on the trend.

In this article, we introduce the topic of Price Shading, so that traders can learn to limit its effects when dealing with a broker that uses this practice - which isn't very honest, yet remains fully legal.

Before exploring Price Shading in detail, it is important to remember some information related to the spot forex market. The forex spot is an interbank market. Banks trade with each other, therefore prices are created based on the big banks' buy and sell orders. This type of trading is not regulated or available on an official or centralised exchange or market, like stock exchanges, it is an over-the-counter market (OTC).

The interbank currency prices are displayed in real time as quotes on trading terminals such as Reuters or Bloomberg. Large banks, investment funds, individual traders and multinationals use these prices to trade with each other.

Brokers have an account with one or more of these banks; they thus have access to offers to buy and sell and can negotiate directly with banks. However, brokers do not generally offer the same prices as those they receive from banks, they increase the price they receive (spread) to make money, which is completely normal. However, some brokers even go so far as to apply Price Shading, which involves adjusting their prices to gain an advantage over their clients.

How do brokers use Price Shading?

Some brokers monitor the flow of orders and use this information to determine the number of traders on the buying side and those on the selling side. They then adjust the price to charge buyers or sellers a little more depending on the trend and the trading volume. For example, if they detect more traders interested in buying than selling, they charge a little more on the buyer's side to increase their profits.

For example, if there are 100 buyers and 100 sellers, the broker gets 1 pip on each transaction, which means a total of 200 pips of profit. But if there are 150 buyers and 50 sellers at a given time, the broker can decide to charge 2 pips on the price for the 150 buyers which means that no profit is made on the sellers. However, this provides the broker with a total profit of 300 pips (150 buyers x 2 pips).

How can you detect Price Shading?

The only way to know if your broker is using this practice is to have access to a Reuters or Bloomber terminal or to open an account with a broker that offers STP (Straight Through Processing) execution. A trader can also open an account with two brokers, a market maker broker and an STP broker. STP brokers don't have a dealing desk (NDD), they don't apply a price spread, but charge a commission on each transaction. This allows the trader to see whether the broker is constantly above the buy quotes of the interbank exchange rates or constantly below the sell quotes of the interbank prices.

Investigating and choosing a good broker

The best way to avoid Price Shading is to take your time and investigate carefully to understand a broker's commission structure and how it makes a profit. Brokers legitimately aim to make money, just like any other business. The trader must therefore find a broker that uses transparent and fair trade practices, and that isn't too greedy.