Gain Capital, a start-up market maker of foreign exchange products for smaller institutions and retail clients, has gone live with its complete Web-based FX trading system.
The system provides 24-hour live trading of Euro/U.S. Dollar, U.S. Dollar/Yen, British Pound/U.S. Dollar and U.S. Dollar/Swiss Franc, and plans to open up the door to other currencies in the near future. Mark Galant, CEO, explains that smaller institutions and, most definitely, individual investors have had a hard time getting in on the foreign exchange markets, because it isn't cost effective for larger banks to deal with the size of orders that hedge funds and the like would like to trade. Given both its trading system and its cost structure, Galant believes he can handle such small trades.
Unlike the differing prices that banks offer large institutional clients, Gain Capital's Web site provides all its clients with the same bid offer for each offering. Investors click on either the bid or offer to buy or sell, and that is immediately routed to one of Gain Capital's traders, of which there are currently eight, four for each 12-hour trading shift. The firm aggregates the trades it makes with these investors-taking on a good amount of risk-and then transacts with one of five banks, what Galant calls "liquidity providers."
"The benefit to the banks is that we're garnering deal flow from clients that they're not marketing to," Galant explains. "Because of cost efficiencies, only we can go after this deal flow. We aggregate the deals from our clients, and we usually go to the banks with trades in the millions. That's the size they're more used to, and we're giving them deal flow they probably wouldn't have gotten otherwise."
Hedge funds and other small institutions that participate receive a number of benefits. Other than access to the forex markets where there was none before, these institutional investors also received very low spreads, spreads that, in fact, are rather atypical of the forex market. As a result, Galant says that many investors using the system are trading as much as 30 or 40 times a day, a number much higher than he expected. "Some of these traders are not only supplementing the way they've traded before, but, in fact, supplanting it," he says. "It's quick, easy, there are no commissions, and we make very tight spreads. I think what's happened is that they haven't seen spreads this tight before."
Also unseen in the forex market, investors using Gain Capital all receive the same price. Typically a large bank will offer large investors a lower price comparative to the market, knowing that they have to sell, and then flip it for an immediate gain. "We decided to do this, because we feel that this dealing practice will become the eventual standard for forex trading, and we wanted to be the harbinger.," he admits. "By offering the cleanest, fairest game in town, that's how we're getting a lot of the flow we're getting."
And flow is necessary for the firm. Galant says Gain Capital is only making "five pips wide," such a small spread that the firm plans to lose money for some time until it can garner the amount of liquidity that would allow its in-house traders to flip a trade in a second's time, making almost the entire spread with its banks. This is no easy task. "When you call up a bank currently for a couple hundred thousand dollars of currency, it could take minutes before you consummate that transaction, and in the foreign exchange market, which moves quite rapidly, the market could be 20, 30 pips away in that time," he points out.
He adds that investors on the system know they are getting a fair market price, because the site includes a feed from InfoTech, which aggregates prices from over 80 large banks around the world. Further, he says, the company needs to offer fair rates or risk being arbitraged. "If the market was 50,55 and we were showing 42,47, someone would buy from us at 47, because they could turn it around and sell at 50. So we have to be on top of the market or someone will bring us back into line through arbitraging our prices against the market's."