B
efore you start trading, you need to choose which broker’s services you would like to use.
Don’t make the mistake to just google it and go for the first one you see.
You need to know what is the difference between them and what they offer.
There are two main types of forex brokers:
- Dealing Desks (DD), also called Market Makers.
- No Dealing Desks (NDD), who can be subdivided into:
- Straight Through Processing (STP)
- Electronic Communication Network + Straight Through Processing (ECN+STP).
What is a Dealing Desk Broker?
A dealing desk Forex broker, also known as a market maker, are brokers who take the other side of a client’s trades. They create a market for their clients.
They are setting both the bid and ask price and the traders use these set terms.
Dealing desk brokers make money by buying at lower prices and selling at higher prices, and by taking advantage of the spreads between the bid and ask price.
In most cases, dealing desk brokers keep trades safely within their own liquidity pools and do not require external liquidity providers.
Some people believe that this type of brokerage takes advantage of the trader, because they control the prices at which orders are filled, but many traders prefer these fixed spreads.
Since DD brokers use artificial quotes, their clients do not see the real interbank market rates.
People often are scared that such brokers will cheat and make the quotes unrealistic. However, the truth hides behind the fact that due to the big competition among brokers , their rates are close, if not the same, to the interbank rates.
Let’s give you an example of how they work:
You place a buy order for GBP/USD for 100,000 units with your Dealing Desk broker.
To fill you, your broker will first try to find a matching sell order from its other clients or pass your trades on to its liquidity provider (a large entity that readily buys or sells a financial asset).
They are doing this to minimize their own risk, as they earn from the spread without taking the opposite side of your trade.
However, if there are no matching orders, they will have to take the opposite side of your trade.
Different forex brokers have different risk management policies, so you need to check with your broker for this matter.
What is a No Dealing Desk Broker?
This is operating mode, which is performed automatically without the interference of a dealer.
This means that they do not take the other side of their clients’ trade as they simply link two parties together.
Instead, they work with liquidity providers to give their clients variable spreads and to match traders with other traders who would like to take the other side of a trade.
On the contrary to Dealing Desk brokers, the execution of the trade with NDD brokers happens almost instantly and there is no room for fear that your order would get filled at a different price.
No dealing desk brokers also tend to have lower spreads than dealing desk brokers or they can charge a small commission.
Since spreads aren’t fixed, this depends on your trading strategy if it comes as an advantage or disadvantage.
No Dealing Desk brokers can either be STP or STP+ECN.
What is an STP Broker?
When a Forex broker uses a straight-through processing system, they route the traders’ orders directly to different liquidity providers on the interbank market. There is zero manual intervention.
These could be large banks, counter-party investors, major investment corporations or hedge funds. An STP broker silently connects traders straight with the interbank market.
No Dealing desk STP brokers usually have many liquidity providers, with each provider quoting its own bid and ask price.
If your NDD STP broker has three different liquidity providers, you will be able to see three different pairs of bid and ask quotes in your trading platform.
Their system then sorts these bid and ask quotes from best to worst.
In this case, the best price on the bid side is 1.3000 (you want to sell high) and the best price on the ask side is 1.3001 (you want to buy low). The bid/ask is now 1.3000/1.3001. (IT WILL BE CHANGED ACCORDING TO QUOTES WE USE AS A GRAPHIC ABOVE)
But don’t get illusions that you will see these exact quotes.
Your broker doesn’t work for free.
To compensate them for their services, your broker adds a small, usually fixed, markup. If their policy is to add a 1-pip markup, the quote you will see on your platform would be 1.2999/1.3002.
You will see a 3-pip spread. The 1-pip spread turns into a 3-pip spread for you.
Let’s say that you decide to buy 100,000 units of EUR/USD at 1.3002, your order is sent through your broker and then routed to either Liquidity Provider A or B.
If your order is acknowledged, Liquidity Provider A or B will have a short position of 100,000 units of EUR/USD 1.3001, and you will have a long position of 100,000 units of EUR/USD at 1.3002.
Your broker will earn 1 PIP in revenue.
The spread of STP brokers is tightly connected to the spread of their liquidity providers.
If the spreads of their liquidity providers widen, they have no choice but to widen their spreads too.
While some STP brokers do offer fixed spreads, most have VARIABLE spreads.
Some of the advantages of STP brokers among retail brokers are NO RE-QUOTING AND NO EXECUTION DELAYS.
What is an ECN Broker?
ECN brokers rely on the so-called Electronic Communication Networks (ECN) for their operations.
This is a digital system that matches up buy and sell orders between participants.Participants could be banks, retail traders, hedge funds, and even other brokers. In essence, participants trade against each other by offering their best bid and ask prices.
Your orders interact directly with the orders of other participants in the ECN. This way there is no room for conflict of interests.
One of the main good characteristics of an ECN broker is transparency.
ECNs allow their clients to see the “Depth of Market”, where the buy and sell orders of other market participants are.
Usually they charge a small COMMISSION for their services.
