You want to ensure that you choose the right type of broker. In order to know how to go about doing this, you have to know what types of brokers are actually out there. You have to take your time, and research all of the available options to know which would be the right one to go with. You cannot just base your decision on the first one who comes knocking on the door.
Out of all the broker types out there, there are always two main types of brokers to choose from. These two types include Dealing Desks or DD, and No Dealing Desks or NDD. DD’s can also be referred to as Market Makers. NDD’s are subdivided into even further groups such as Straight Through Processing or STP, or Electronic Communication Network and Straight Through Processing or ECN+STP.
What Specifically is a “Dealing Desk Broker”?
The Forex brokers that operate through this type of account or Dealing Desk make their money by going through spreads and trading against their clients who hire them. These Market Makers create a market with artificial Forex exchange rates for their clients to use and see. These types of brokers are pretty much indifferent to the decision that the trader makes since the money from the client goes directly to them. They will sell and buy a quote without communicating to the client.
The Market Makers are initially in control when it comes to the client’s money. They control the prices, and the amount that client is to put down because of the prices that they make up. There is very little risk that they will set fixed spreads for you to use. The clients who do deal with the Dealing Desk brokers do not actually deal with the real interbank market rates that are out there. The competition between markets and brokers is stiff, and the rates that are offered by both parties are close and pretty much the same to the interbank rate, even if you do not see the actual rate for yourself.
If you trade using a Dealing Desk broker, then it normally will take place in this order:
Trader > Trading Order > Trading Platform > Then Goes to Dealing Desk — Winning Trades of Clients — Losing Trades of Clients
If you place an order from the broker for a buy in EUR or USD for 100,000 units, and you’re hiring a Dealing Desk broker, there are certain steps to take. In order for the broker to fill your account, they need to find a matching sell order from any other clients that they have or can find. If they cannot, then the trades have to be passed on to its liquidity provider. The liquidity provider is a sizable entity that readily buys or sells one of your financial assets.
If the brokers do the trades this way, then they minimize the risks involved when they earn from the spread without taking the opposite side of the trade deal. If there are no matching orders, however, they will have to take the side of the opposite trade. Each broker that you encounter has different management policies for the risks that they take. You want to check with the broker that you work with for this.
What Does a “No Dealing Desk Broker” Do?
The No Dealing Desk Brokers are the ones who do not pass their clients’ orders through a Dealing Desk. They do not take the opposite side of the trades since they just link two parties together.
The trading platform for a No Dealing Desk Broker looks somewhat like this process:
Trader > Trading Order > Trading Platform > ‘Straight Through’ the Interbank Market
- Hedge Funds
- Mutual Funds
- Other Clients
- Other Brokers
These No Dealing Desk Brokers act pretty much like bridge builders since they build a structure over the hard to pass area and connect the two areas. They can charge a very small commission for their trading services, or they can put a markup by increasing the amount for the spread, slightly higher. They can either be in the STP or STP+ECN areas.
What Do “STP Brokers” Do?
A lot of brokers out there think, or say, that they are ECN brokers, but in actuality, they’re not. They normally turn out to be Straight Through Processing system workers. They have a straight forward, always in place STP system route the orders that they receive from their clients. This system then sends their clients’ orders to the liquidity providers that have access to the interbank market directly. Normally a NDD STP broker has a large number of liquidity providers, and each of these providers has their own quote for bid and ask prices.
If there are three different liquidity providers, through their system they can see all of the different pairs of providers and each of their bid and ask quotes.
|Liquidity Provider 1||1.2998||1.3001|
|Liquidity Provider 2||1.2999||1.3001|
|Liquidity Provider 3||1.3000||1.3002|
The system that they use will then sort these bid and ask quotes determining which the worst is and which the best is. You want to make sure you bid high, and buy low in this situation. This is not the quote that you will see on your platform, however, since the broker actually takes a cut from the high/low bid and buy.
To compensate for their work, they will usually add a small, fixed markup on the quote. When you feel ready to buy, then the quote is put through to the broker who then sends it to the liquidity provider. If the order is accepted, then they will hold the short position of the 100,000 units that you put in, and you will have the long position. Your broker then earns 1 pip in revenue from this transaction.
The changing bid/ask quote is the reason for the STP brokers to have a number of variable spreads that are subject to change. If the spreads widen, then they actually have no choice but to widen the spreads of their own as well. Some STP brokers will offer fixed spreads, but the majority of them offer variable spreads.
What Do “ECN Brokers” Do?
ECN brokers allow the order of their clients to interact directly to the orders of other participants in the ECN. The participants can be a number of different people. Some of them include banks, retail traders, hedge funds, and other brokers who are putting in. They all trade against each other by offering their best bids and asking prices on one platform.
When working with ECN’s, they allow their clients to see the depth of the market. This is where they buy and sell orders through and from other market participants. ECN is a very hard area to put a fixed mark up on. This is why a number of ECN brokers are usually paid a small commission for their work.
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