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A business using this approach is called a Bucket Shop - it's both fairly well-known and explicitly illegal in most places: https://en.wikipedia.org/wiki/Bucket_shop_(stock_market)

Interesting, thanks for the link. I wish there were some comprehensive list or taxonomy on these kinds of scams.

There was a really interesting talk I saw a few years back that dealt with this sort of thing. Very much worth watching:

https://www.youtube.com/watch?v=L7G0OfJUON8

It's also very similar to 'spread betting', explicitly legal in the UK and a large industry.

I have a hard time telling the difference between the “bucket shop” described in the lede there and a modern options trading market.

I guess the difference is that in a market third parties eat the spread by market making whereas in a bucket shop the market itself profits off the spread?

I'm not sure if it's the only difference, but according to the wikipedia definition, in a bucket shop there is "no transfer or delivery of the stock or commodities nominally dealt in", which would be one difference from the option market.

I don’t think most commodities traders actually transfer or take delivery of the commodities though. Sure there are some firms that actually are engaged in the commodities business, and use the futures markets to offset price risk, but most traders in the commodities markets are basically just betting on commodities prices.

The nominal dealing on a future's market will be on some paper that entitles the holder to the commodity delivery at a future date. When you buy oil futures, you are NOT buying oil since the oil doesn't exist (well I guess it exists underground somewhere, maybe), you are buying a contract to deliver crude oil and that needs to really exist. If the contracts don't exist that's a Bucket Shop.

It matters when things go badly wrong, because with a Bucket Shop you're left penniless, it was all imaginary anyway. Whereas with a futures market even if the exchange blows up those are real contracts you can sell to somebody who wants the commodity you were trading in, at worst a mild inconvenience and a small haircut to your final profit.

You may be confusing the exchange with a broker. With a serious commodities broker, you’re using the services of the broker to trade on an exchange, e.g. the CME. The broker does not particularly care whether you make or lose money, so long as you don’t actually go negative.

In the US, securities brokers are very heavily regulated — see “regulation NMS”.

I don't think so (I am not an expert though so it's possible), my point was that even if the exchange, not just your broker, blows up, the thing you were buying and selling is a real thing anyway, unlike in a Bucket Shop.

The bucket shops described in https://en.wikipedia.org/wiki/Reminiscences_of_a_Stock_Opera... operated by offering incredible leverage and using actual ticker tape quotes, which, at the time, were delayed slightly.

They offered the 'service' of being able to trade large nominal amounts at the last market price, without market impact, but had incredible levels of margin -- 50-1+ or something like that.

This meant that customers often hit margin limits, incurring additional 'commissions' to close out their positions.

Operationally, the bucket shop netted long and short positions, and either actually traded the residual or, occasionally, would use market orders (e.g. aggressive sells) to push the punters into margin calls, which they would then execute. They would then buy low and cover their earlier positions.

Jesse Livermore managed to beat them through astute technical analysis and through the installation of a direct telegraph line from the exchange, thus beating his 'brokers', who promptly kicked him out.

When I worked in Forex (~1999-2003) this was common practice, at least where I worked. Bring in customers, teach them the bare minimum, and let them trade with 100:1 (and sometimes 200:1 leverage). Even better, because 99% of customers lose, we would "assume the risk" of most trades, accepting their trades but not offloading them to larger banks (ABN, Deutsche, etc), so their loss was all profit. If someone demonstrated they were a decent trader (very, very rare), we would set a special bit on their account and, from then on, offload their trades to major banks at better spreads than we offered to the customer, making 5-10 pips per transaction. Most of the "decent" traders traded in huge lots (10-100 millions), so making 5-10 pips per transaction was substantial. Long story short, you make money on the crappy traders and on the good traders, and the good traders were even better because they would keep coming back.

> To improve this, the broker can throw out the best performing clients, since they might genuinely know what they’re doing.

In a parallel space this is happening in the UK with bookmakers. Winning punters either have their accounts heavily restricted, i.e. only able to place small value bets, or their accounts closed entirely.

Certain states in Australia had to introduce legislation to guarantee a bet size the bookmakers must stand. From memory it was $500 on country race meetings and $1000 on metropolitan meetings.

  To improve this, the broker can throw out the best
  performing clients, since they might genuinely
  know what they’re doing.

This practice is pervasive in sports betting. It's a common practice to ban winners, especially in the US and UK.

https://augur.net is an Ethereum-based betting market that will help traders/bettors avoid these kinds of malicious practices. Augur v2 is being developed now, you can expect it to be Really Cool by about April 2020. Millions of dollars will be wagered on Augur for the 2020 election.

Betting could very well be the killer feature for Ethereum.

So far betting seems to be the ONLY feature for all things blockchain. In China quite a few of my friends went to make games on the blockchain during the wave of cryptocurrency mania. That didn't work out so they then went on to make (illegal) gambling games on the blockchain, although that didn't really workout quite as well either (apparently something to do with generating random numbers on the blockchain)

I worked on a Bitcoin sports betting site. Been there, done that.

You don't have to throw out the clients that perform well! You charge them fees and send their orders to market.

Maybe front-run them a bit if you're into that.

>If, indeed, the client is trading based on no information whatsoever, then the broker wins and the client loses.

If this were the case, wouldnt both sides just make 0$ on average over a long period of time? (or whatever the avg growth of the market was during this period)

I guess the broker would earn fees, but that still doesn't exactly sound lucrative

For the kind of trader that clicks on a computer all day, fees and spreads (which are not always easy to tell apart) can easily dominate price movement.

I urge people who care at all about how stock exchanges actually work -- it's substantially worse than what you describe -- to read 'Flash Boys: A Wall Street Revolt' by Michael Lewis.

https://www.sec.gov/news/press-release/2018-178

Presumably this strategy would land the operators in jail if enough of their traders successfully predicted a large enough market move.