Forex Brokers And How They Differ From Each Other
Every time a new trader decides to venture in to the Forex trading market, there a couple of major necessities to cover which include, learning the basic trading strategies and styles of the forex world. Another major necessity to cover is the separation of funds that will be used to invest in a reputable broker. A very important factor to consider as not all brokers are the same, so choosing the right one will have an effect on the quality of your transaction fees, service and dealing spreads. Before you however decide to dump your money on a broker, it is highly recommended that you compare and weigh out your broker options so you understand which of the broker types are right for you.
It has now become more of an issue to differentiate among brokers since there are so many, making it hard to ascertain which of them can provide the solution to some of your trading needs. Before we start picking out the different types of Forex brokers, we’ll start from the beginning and explain whom Forex brokers are.
What is a Forex Broker ?
Simply put, a forex broker is a company or a firm that provides traders with a trading account and a platform that allows them to speculate, buy and sell on currency movements in the Forex market. This is the only thing Forex brokers have in common with each other; providing you with an account and a platform on which you can make your trades. Besides that, their fee structure, the way they place your orders on currencies and even their selection of currencies to make available all differ.
A forex broker also known as a currency-trading broker or a retail forex broker only covers a tiny portion of the foreign exchange market and some of them will offer you a practice account so you can have a feel as to what the trading system is like. It is still advisable to try out various platforms before you conclude on which broker to use.
It is our hope that after knowing the different types of brokers as well as what makes them differ, you will be able to make the right choice in discerning what broker will be right for you.
Major Ways Brokers Operate
Despite the fact that majority of the Forex Brokers all offer the same form of service, everything is really not that simple when you look behind the curtain. Forex Brokers operate in two major ways and choosing any of their modes of operation will definitely influence on your trading experience.
- Dealing Desk (DD) : This form of operation is derived from the position where a trader would have an actual desk to sit on and manage an organization’s investments. In todays market any broker who works with a dealing desk sets their price rates and matches the buy and sell order of their clients in a closed environment. These brokers are called Market Makers (MM).
- No Dealing Desk (NDD) : Brokers who do not have dealing desks are able to obtain their quotes and process the market orders by relating them to hedge funds, banks and other brokers. If a broker doesn’t have a dealing desk, then that broker is either a Straight Through Processing broker (STP) or an Electronic Communication Network broker (ECN).
Types Of Forex Brokers
MM brokers are as their name suggests the brokers who create markets for their clients; this means that all of their deals are directed on the internal market they have created, which is a depiction of the actual interbank market. Now these deals are carried out through an inventory or by going through the order pool that comes from other clients to find counterparty, so a client basically competes with arbitrators instead of actual Forex participants.
Since Market Makers do not take the deals to the actual interbank market, they are therefore able to set their own prices. Some people choose to believe that Market Makers usually bet against their client’s success or take the other side of the clients trade since they are the ones who create the market for them, this is not certain and there is no conflict of interest involved because the buy and sell price quotes that Market Makers provide both move together, this means that since they fill both orders (buy and sell) of their clients, they remain unresponsive to an individual traders decisions.
For example if an order is placed to buy GBP/USD for a certain amount of units through your Market Maker Broker. The broker first tries to find a matching opposite (Sell) order from any of its other clients if that isn’t possible, the trade is then passed on to the liquidity provider. This is their own method of minimizing risk, as they earn their gain not from taking the other side of the trade but rather from the spread. If however there are no orders to match with yours, then they will eventually have to tae the other side of the trade. But remember that different brokers manage their risks in different ways since Market Maker brokers control the prices for filling orders there is hardly any risk available if they set fixed spreads, making it an ideal option for beginners. It is still recommended to check with your selected broker first to know what sort of policies they offer.
Advantages & Disadvantages of The Market Maker
- Your selected trades are carried out immediately at the rate of your choosing
- A wide choice of leverages to indulge your risk
- You know exactly what spread you’ll be paying for soon as you enter a trade
- There is no additional or rollover fee to pay since the currencies do not change hands and are balanced out by counter orders.
- Slim chance of the prices deviating from that of the inter market
- If the dealing desk is not managed properly, there is a possibility of the broker going bankrupt
- If a counter-party can’t be found for your order and the broker isn’t willing to take it, then there is a chance that the liquidity could be low.
The Straight Through Processing Broker (STP)
Transactions that are processed through this mode employ a no dealing desk method and occasionally some practices of the Market Maker so as to deliver trading opportunities that are more flexible for their clients. The STP trader sometimes displays Market Maker tendencies when an order has to be matched and a counterparty cannot be found for that order, The STP broker may then accept to counterparty the order itself. This enables them evade the restraints of exclusive trading inside the interbank market.
Most STP brokers make use of algorithms that help them decide if it is a more profitable option to trade against your order or to simply move your trade to the interbank market. A client might prefer this broker option and consider it to be a combination of two worlds, since the broker does not manipulate prices but rather gains profit by covering smaller trades that might be losing and move the larger, more profitable trades to the interbank market.
Advantages & Disadvantages of The Straight Through Processing Broker
- Make More Trades of Smaller Sizes
- Identical prices to the rates of interbank
- Trades are rejected only when there is high volatility in the market
- Availability of a wide choice of leverages
- Rollover fees are included
- A trader will usually be unsure about what the spread will be when entering a trade
The Electronic Communications Network (ECN)
An ECN broker is a no dealing desk broker just like the STP but rather offers a platform that allows traders, market maker banks and market participants to directly connect in the interbank market. The brokers only role in this scenario is simply to create the link between both the buyers and the sellers. The broker does not set the price, neither is he able to manage inventories, as the price is gotten straight from the interbank market. A major advantage to this is that there is a level of anonymity for the trader who posts the price giving them the opportunity to conceal the fact that they are also in on the bid.
These types of brokers can make their Profits off the extra spreads from trade execution and the interbank buy and sell commissions. A downside to this however is that the dynamics of the interbank market cannot grant the ECN broker the opportunity to fix spreads, because it will result in a higher chance of removing their commission. It is a fixed market and the ECN broker can only get paid through that commission.
Using an ECN broker gives the client trader the option of seeing the Depth of Market, which is where one can view both the buy and sell orders of other participants in the market
Since it sounds like a simple choice for a trader, it is wise to know that many parties in the interbank market usually make very large trades and so it will need a high capital for investment. An ECN broker could require a minimum account of $1 to $50 thousand, plus they cannot guarantee that within the interbank there would be a party ready to take your deal at your quoted price, thereby pushing them to have to reject your order or to issue a re-quote on your chosen price. Again, it may seem like a simple choice to use an ECN broker but it does however produce a number of challenges for the client trader.
Advantages & Disadvantages of The ECN Broker
- The broker cannot trade against the client
- The spread rate is tight
- The price rates are directly from the interbank market and do not differ
- The broker cannot go bankrupt if they trade against the client
- You need to pay commission
- There are rollover fees
- They can reject your trades and issue re-quotes
- Your leverage is limited
The world largest financial market is the forex market and since it has no central marketplace, traders who wish to use its services have to select a broker that is capable of helping them handle their trade activities. Bringing us to the issue of broker dependency. There is a wide variation of forex brokers who bring their own tailor made feeds, established from the inputs that they get from liquidity providers. These brokers differ in various aspects ranging from their indicator comparisons, their spread, their execution methods and their spillage. This shows that research is very necessary when attempting to pick a broker that can fit your trading style. However here are a few tips you can consider when selecting your forex broker
- Customer Support: Since the forex market is open 24hrs a day for trading, a broker should be available to provide a client with support on a regular basis. Your selected broker should have a live person that can attend to your needs rather than an auto attendant.
- Trading Platform: This is the doorway to the trading market, it is what gives you access to buy and sell on your chosen trades. And as such the interface of a trading platform should be easy to use as a platform with a poor interface could lead to very costly mistakes. A proper platforms interface should have very clear buy and sell buttons.
- Currency Pairs Offered: Despite the fact that there are loads of currency pairs offered on the foreign exchange market for trading, just a certain few garner the most attention and trade with the most liquidity. Check through the pairs that a broker offers before selecting, as they could have all the major pairs but not the pair that you’re interested in trading.
- Regulatory Compliance: A flashy looking website with a nice interface does not guarantee that the broker is recognized by a regulatory organization. A trustworthy broker in America for example will be a member of the National Futures Association (NFA). Check through your prospective brokers profile, if they are recognized they would post it in their about us section or their home page as a show to gain more clients.