Different Types of Forex Brokers That You Must Know Before Trading
In order to make money trading the Forex market, you’ll need a Forex Broker. To better understand what a Forex Broker is let’s continue with an analogy: Let’s say you want to buy an orange from the grocery store so you go to the public market. This is the place where you can buy oranges because that is where there are people selling oranges.
Now, assume you want to sell oranges and in order to find some customers you need to go to the public market because that is where you’ll find them. A public market is a place where buyers and sellers meet and similarly things happen in the financial market. In the Forex market, the buyers and sellers need a place in order to trade with each other and this is where the brokers come in.
There are two different types of Forex Brokers:
- Dealing Desk Brokers (DD) or Market Makers;
- No Dealing Desk Brokers (NDD) which can be divided into two categories:
- Straight Through Processing (STP);
- Electronic Communication Network + Straight Through Processing (ECN+STP)
What is a Dealing Desk Forex Broker?
A dealing Desk Forex Broker is also called a market maker which literally creates a market for their clients. These type of Forex brokers make money through charging their clients the spread. A Dealing Desk Broker also provides liquidity for their clients, they provide both the sell or bid and buy or ask quote. In essence, a Dealing Desk Broker is the counterpart of your trades so the broker trades against your positions.
Dealing Desk Forex Broker – Advantages and Disadvantages
In a Dealing Desk type of environment, the broker has full control over your position and because of this your trades can be executed at worse prices than what you could get with a No Dealing Desk Broker. There is obviously a conflict of interest because the Dealing Desk broker also makes money from every one of your losing trades.
If you win consistently on a long-term basis your account can be banned or suspended or your profits can even go into the greedy broker’s pocket. The main advantage of a Dealing Desk Broker is the fact that you can open an account with as little as $100. You can also have access to higher leverage that can reach even 1:500.
What is a No Dealing Desk Forex Broker?
The No Dealing Desk environment is a way of Forex trading that provides immediate access to the Interbank market. The Interbank market is the place where the Forex currencies are traded. In a No Dealing Desk environment, positions are automatically offset and then transmitted directly through the Interbank market. When trading through a No Dealing Desk Broker instead of dealing with one liquidity provider an investor has access to numerous liquidity providers.
No Dealing Desk Forex Broker – Advantages and Disadvatantages
The number one advantages of a No Dealing Desk Broker are the fact that there is no inherent conflict of interest. No Dealing Desk brokerage firms don’t trade against their clients as facilitators of trading they don’t take a position that may from time to time conflict with the interest of individual traders. You also have competitive and better Forex quotes.
There are plenty of disadvantage trading through a No Dealing Desk Broker like the higher cost of trading as you’ll have to pay on top of the spreads a commission fee. The minimum amount to open a Forex account is higher through these type of Forex brokers and can go as high as $50k for some reputable brokers.
What is an STP Broker?
STP or Straight Through Processing was made possible as technology could process trades increasingly efficiently. In this type of trading environment as the name suggests, the orders are processed straight through the Interbank market. The STP model is a liquidity aggregator that facilitates and tries to match buyers and sellers.
To better understand how the STP model works let’s look through a real example:
- You go long EUR/USD;
- STP broker goes short EUR/USD as your counterparty;
- STP broker goes also long EUR/USD to hedge the trade so there will be no conflict of interest;
- Market short EUR/USD;
- Your trade has reached the market.
What is an ECN Broker?
ECN stands for Electronic Communication Network and is a trading network where orders are executed without the orders going through a dealing desk. Simply put it, the ECN model allows traders to directly interact with each other anonymously by posting bids and offers inside the broker’s internal order book. In the ECN model, the quotes are derived directly from the Interbank market. They way an ECN Broker makes money is through a small commission charged to their clients.
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