Aside from forex brokers who “A-Book” or “B-Book“, you might also come across the term “C-Book”.
“C-Book” is a term that’s used to describe “risk management strategies” that forex brokers and CFD providers use that are supposedly different from A-Book or B-Book.
In our opinion, “C-Book” is just marketing jargon.
It’s not really a different approach that brokers use to manage risk, it’s more of a vague term to describe variations or tweaks of A-Book and B-Book execution.
As you’ll see, “C-Book execution” isn’t really used by the broker to manage risk, but to try and make more money for itself!
These execution methods are also considered controversial and it’s questionable whether forex brokers should be doing them. We’ll leave it up to you to be the judge.
Let’s cover three forms of “C-Booking”:
- Partial hedging
- “Overhedging”
- “Reverse hedging”
Partial Hedge
The most common form of “C-Book execution” is the partial hedging of a customer’s order.
A broker can hedge market risk in part and not in its entirety. This will reduce, but not eliminate, adverse price movements to the position being hedged.
The risk that remains unhedged, also known as residual risk, gives the broker the opportunity to profit IF the price moves in its favor.
Think of this risk management strategy as a “partial A-Book” and “partial B-Book”.
Basically, the broker has A-Booked a certain percentage of its risk and has B-Booked the rest.
Let’s look at an example where a broker hedges 50% of a customer’s position.
Elsa opens a long EUR/USD position at 1.2001.
Her position size is 1,000,000 units or 10 standard lots. This means a 1-pip move equals $100.
The broker hedges 50% of the risk by opening a long 500,000 EUR/USD position with an LP at 1.2000.
(If it had gone long the entire 1,000,000 units, this would be considered A-Book, since 100% of the position is hedged.)
EUR/USD rises in price.
Elsa wants to take profit and exits her trade at 1.2101, resulting in a gain of 100 pips or $10,000 ($100 x 100 pips).
For the broker, this means a $10,000 loss.
If the broker had just B-Booked Elsa’s trade, it would’ve had to eat the entire loss.
But fortunately, it hedged part of Elsa’s trade.
While the hedge trade resulted in a gain of 102 pips, since the position size was 500,000 (half of the 1,000,000), the profit was $5,100.
This profit made from the LP helped reduce some of the losses from Elsa’s trade, so the net loss was $4,900 (instead of the full $10,000).
Conversely, if the EUR/USD fell, the profits of the broker against Elsa would be reduced by the losses incurred from hedging.
In this example, Elsa opens a long EUR/USD position at 1.2001.
The broker hedges 50% of the risk by opening a long 500,000 EUR/USD position with an LP at 1.2000.
EUR/USD falls in price.
Elsa’s stop-loss is hit and her trade is exited at 1.1951, resulting in a loss of 50 pips or $5,000.
For the broker, this means a $5,000 gain.
If the broker had just B-Booked Elsa’s trade, it would’ve kept all this profit.
But it didn’t, it hedged part of Elsa’s trade.
The hedge trade resulted in a loss of 48 pips. Since the position size was 500,000 (half of the 1,000,000), the loss was $2,400.
This loss suffered from the LP helped reduce some of the profit from Elsa’s trade, so the net profit was $2,600 (instead of the full $5,000).
So far, you’ve seen how a broker can fully hedge (=100%) against a customer’s position, known as A-Book. And you’ve seen how a broker can partially hedge (<100%) against a customer’s position, known as C-Book.
“Overhedge”
C-Booking is not limited to partial hedging.
Another variant of C-Booking is when a broker can also choose to “overhedge”, meaning it can hedge more than 100% of a customer’s position.
For example, instead of a hedge trade that covers 100%, it can choose to hedge 110%.
Rather than “C-Book”, a more accurate name would probably be “A-Book+“.
Why would a broker want to do this?
If the broker thinks the customer’s trade will make a profit, it can “ride along” with the customer and make some extra profits.
Elsa opens a long 1,000,000 EUR/USD position at 1.2001, which means the broker is now short 1,000,000 EUR/USD.
Here, the broker can decide to:
- Not hedge (B-Book)
- Partially hedge (C-Book)
- 100% hedge (A-Book)
- >100% hedge (C-Book)
The broker has profiled Elsa as an informed trader and chooses option #4.
It hedges 110% of the risk.
It goes long 1,100,000 EUR/USD with an LP at 1.2000.
If it A-Booked the trade, it would’ve gone long 1,000,000.
Instead, it went long 1,00,000 plus an additional 100,000 units or the equivalent of 110% Elsa’s position size.
Elsa turns out right and EUR/USD rises.
She exits her trade for a gain of 100 pips or $10,000.
Obviously, this means the broker has a loss of $10,000.
But….notice its P&L with the LP.
Since the broker “overhedged” and had a bigger position size against the LP, its profit from the LP exceeded its loss from Elsa.
The broker was able to “juice” its profits.
This “overhedging” strategy is not without risks though.
Let’s see what happens when the customer loses.
In this scenario, EUR/USD falls and Elsa exits her trade at a loss of $10,000.
Obviously, this means the broker has a gain of $10,000.
But….notice its P&L with the LP.
Since the broker “overhedged” and had a bigger position size against the LP, its loss from the LP exceeded its profit from Elsa.
This is the tradeoff if the broker’s hedge exceeds 100%.
It exposes itself to greater loss if the customer ends up wrong.
“Reverse Hedge”
Another variant of C-Booking is when a broker “reverse hedges” a customer’s trade either partially or completely.
This practice is based on the assumption that a customer trades so poorly, it’s possible to make money by not only B-Booking the position but to ADD on to the B-Booked position!
Rather than another variant of “C-Book”, a more accurate name would probably be “B-Book+“.
Basically, the broker does not even try to hedge or transfer market risk, it purposely takes on MORE market risk!
When a broker chooses to “reverse hedge” a customer’s trade completely, it is basically increasing its B-Book risk.
Elsa goes long 1,000,000 EUR/USD at 1.2001.
Since the broker is Elsa’s counterparty, it is now short 1,000,000 EUR/USD.
The broker is now exposed to market risk (if EUR/USD rises).
If we stop here, this would be B-Book execution.
Does the broker wish to A-Book the trade and completely hedge?
Nope.
It has profiled Elsa as an unprofitable trader so instead of completely or even partially hedging with an LP, it decides to “reverse hedge” 50% of the trade.
So instead of going long EUR/USD, which is what it would’ve done to cover its market exposure, it goes short 500,000 units with an LP!
Remember, it is already short 1,000,000 units against its customer. But it ADDED even more risk exposure with the additional 500,000 units against the LP.
In this scenario, the broker turned out correct.
EUR/USD did fall.
Elsa exited her trade with a loss, which translates to a gain for the broker.
But its trade with the LP also resulted in a gain.
As long as the broker chooses correctly which trade to “reverse hedge”, this strategy can be very lucrative.
But if it chooses wrong, the risk it exposes itself to is even greater than if it had B-Booked the trades and would result in much bigger losses.
Here’s an example where it doesn’t go well for the broker.
Elsa goes long 1,000,000 EUR/USD at 1.2001.
Since the broker is Elsa’s counterparty, it is now short 1,000,000 EUR/USD.
Instead of going long EUR/USD, which is what it would’ve done to cover its market exposure, it goes short 500,000 units with an LP.
Remember, it is already short 1,000,000 units against its customer. But it ADDED more risk exposure with the additional 500,000 units against the LP.
EUR/USD rises.
Elsa exited her trade with a gain, which translates to a loss for the broker.
If the broker had A-Booked and opened a hedge trade with an LP, it would’ve had a gain from the LP to offset its loss with Elsa.
Instead, its trade with the LP also resulted in a loss.🤦