October 16, 2017
When choosing a forex broker, it’s very important to understand which types of brokers exist and what their main characteristics are. This will be covered in this article.
You’ve probably heard about the definitions “dealing desk,” “no dealing desk,” “market makers,” “straight through processing,” etc., but do you know what all this means? Let’s explain it now. There are two primary types of forex brokers:
1) Dealing Desk brokers (DD)
2) No Dealing Desk brokers (NDD)
No Dealing Desk brokers are further divided into:
a) Straight Through Processing (STP) brokers
b) Electronic Communication Network + Straight Through Processing (ECN + STP)
Let’s explain each of the listed types of brokers.
Dealing Desk Brokers (DD)
Dealing Desk brokers are also called “market makers,” as they are the entity that provides liquidity to their traders. They create a market for their client, which means they take the other side of a client’s position.
Just like other brokers, dealing desk brokers make money through the difference in bid and ask price, called the spread. Since they set both the bid and ask price, dealing desk brokers offer fixed spreads for their clients. This means that traders don’t see real interbank rates, but with the advance of technology and the huge competition between brokers, the offered rates are literally the same as interbank rates.
If you place a trade with your dealing desk broker, they will first try to find a matching opposite order from their existing clients to minimize their risk. If there is no matching order, dealing desk brokers will need to take the opposite side of your trade. If a trader performs well and is profitable, a dealing desk broker will usually pass his trades to the market and liquidity providers so they don’t have any risk while holding his profitable position.
The next chart shows the main difference between dealing desk and no dealing desk brokers.
No Dealing Desk Brokers
NDD brokers do not match their clients’ positions through a dealing desk, but send them automatically to the interbank market. They simply link their clients with the liquidity providers, and charge either a small commission for doing so, or have slightly higher spreads than dealing desk brokers.
NDD brokers can be straight through processing (STP), or straight through processing + electronic communication network (STP+ECN) brokers.
STP and ECN Brokers
STP brokers pass your order to their liquidity providers which have access to the interbank market. STP brokers have many liquidity providers, which offer different bid and ask prices for a currency pair. They sort their quotes by the highest bid prices, and lowest ask prices, add a small markup to the price and quote the price to their clients.
That’s why STP brokers usually charge slightly higher spreads than dealing desk brokers, and can also have a variable spread to compensate if their liquidity providers widen their spreads.
ECN brokers on the other hand, create a platform for market participants where they can directly trade against each other. They are doing so by offering their best bid and ask prices, and orders are then matched based on the best possible prices. ECN brokers can connect many different types of market participants like traders, hedge funds, banks, and even other brokers. The nature of their business makes it difficult to charge spreads, and that’s why they will charge a small connection for connecting the various market participants together. ECN broker usually have higher deposit requirements than other types of brokers.
The following table shows the difference between the different types of forex brokers.
Test Your Knowledge: Different Types of Currency Brokers
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The Different Types of Currency Brokers
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Question 1 of 3
The 2 Primary types of Forex brokers are Daily Desk brokers and No Dealing Desk brokers.Correct
Question 2 of 3
Dealing Desk brokers are also called?Correct
Question 3 of 3
Straight Through Processing (STP) brokers:Correct