All Forex brokers can be divided into several groups according to their business model.
Types of Forex Brokers
- Dealing Desk (DD) brokers
- No Dealing Desk (NDD) brokers
- Brokers who have a mixed business model
In turn NDD-Brokers may be divided into two subgroups:
- Straight Through Processing (STP)
- Electronic Communications Network (ECN)
Dealing Desk Brokers
A DD Broker – the so-called Dealing Desk – works by issuing its own orders and maintaining fixed spreads. Dealing Desk-brokers earn on spreads and trade against their clients. This is called market participant or market maker. In fact, it describes its own activities: a market maker “makes the market”.
When traders want to sell any financial instrument, the DD broker buys it; when traders want to buy, the DD Broker sells. Thus, the market maker is always ready to become a counterparty to their clients – to put a counter-order and make a deal. Such DD-brokers are also called dealing centers.
When working through a dealing desk traders do not see the market prices that allow market makers to manipulate quotations at anytime.
Market Maker
A market maker – is another type of broker that earns on the difference in the spread as well as any losing trades that the clients make, as market makers are trading against their clients, taking a second (opposite) side of the transactions.
In the case of trade through the Dealing Desk-broker you should be aware that the counterparty is a market maker who is able to monitor the actions of any client. In the worst case scenario, market makers can “share” all customer groups. For example, one group of customers may be less successful, and the processing of orders is placed in the auto-execute. In most cases, these clients suffer losses, and the dealer, respectively, a profit. In the other group customers can yield a higher performance, they are monitored more carefully, slowly, with possible frequent requoting. In periods of high volatility customer orders in this group will be executed in the second place, while the dealer will try to reduce their own risks. Thus, the operation and integrity of a Dealing Desk-broker depends on the internal regulations of the company.
No Dealing Desk Broker
NDD (No Dealing Desk) – a broker that provides customers with access to the interbank market without processing orders like market makers on the dealing desk. Using this system helps to avoid requoting (delay in the confirmation of orders). In fact, it allows traders to trade without restrictions.
For profit NDD-broker may either establish a commission for transactions, or increase the spread and then allow clients to trade without commission. There are two types of NDD brokers: STP or ECN + STP.
STP (Straight Through Processing)
STP-brokers send orders directly from clients to the liquidity providers – international banks. STP-brokers may have a single supplier or multiple suppliers. The greater the number of banks involved in the process, accordingly, the greater the liquidity and the better for the customers.
The main essence of the STP-platform is access to the real market traders and the market price, plus the possibility of immediate execution of orders without dealer intervention.
An STP-broker, such as ICMarkets offers the choice of either fixed or floating spreads. As mentioned above, STP-brokers organise trading through international banks. They are intermediaries between their clients and banks, receive quotes (and spread, respectively) announced in the interbank market. According to statistics, most banks offer fixed spreads and are themselves market makers. In addition, an STP-broker can choose to either leave your spreads fixed, or reset the specified fixed spread and let the system select the best prices (the bid/buy and ask/sell).
As STP brokers they do not trade against their clients, they often make money by “adding” a little to the spread (spread mark-ups). This can be done by adding a certain amount of pips (typically 1-2 points) for the best price bid, and by deducting the same number of points from the best prices ask, proposed by liquidity providers.
ECN (Electronic Communications Network)
The ECN is a system in the Forex market which allows trading participants to trade directly with each other. It provides a platform where all market participants (banks, market makers and individual traders) interact with each other, exposing in competitive bids for the purchase and sale. Thus, at each time a trader can execute your order at the best price, in the existing system. All trading orders are reduced between counterparties in real time. This system always requires a small fee for transactions – a commission.
Sometimes STP-brokers call themselves ECN-brokers. But to be a true ECN-broker, they must show the “depth of the market” (DOM) via market “cups”, which allows clients to see their own order, size and position in comparison with other orders, as well as allowing participants to see all active orders of other customers. Thus, when trading via ECN brokers, you can determine liquidity in the market and make educated trading decisions. ECN brokers have floating spreads, as they adapt to market volatility and also charge a commission when you open a trade.
Advantages of Trading in NDD Brokers
The main reasons due to which traders choose NDD brokers are transparency and anonymity, as well as better and faster execution. Transparency means that the trader is playing in the real market, not one artificially created for him. They can get the best prices – the result of competing bids for the purchase and sale. Meanwhile, anonymity means that all customer orders are executed automatically, immediately and anonymously, as opposed to trading via the dealing desk, where orders can be executed only after confirmation from a dealer.
Final Thoughts
To sum up, it can be noted that ECN brokers earn less than the other dealers operating in the Forex market. They receive only a commission, rather than profit from the difference in the spread. Thus, they are interested in their customers earning, otherwise they themselves will not earn even a commission.
STP-brokers earn on spreads. Even without the involvement of a dealing desk, they can set their own prices (through the “spread-allowance”). But earning a spread, STP-brokers send trade orders directly from clients to the liquidity providers, providing its customers with a convenient and modern system for trade, and establish the reduced amount of the initial deposit, guaranteeing fast order execution and trading anonymity. STP brokers are also interested in customers making profit to continue earning on spreads.
Market makers earn spreads and occupy customers opposite positions. However, if the client becomes too profitable (and therefore, unprofitable for the company), it may “upset” the DD broker. While a professional high reputation market-maker could afford such a client, a smaller dealer may block the customer access to its site.
Forex brokers are not bad in general, whether Dealing or Non-Dealing Desk. Usually they do not trade against any trader rather try to work not only in the field of cooperation with customers, but also to themselves, thus keeping your business. Many large brokers who have thousands of customers, try to help them to become successful traders. But as soon as the trading order is placed, it’s everyone for him or herself.
Rather than trading only in one type of broker, you may wish to split your eggs into different baskets and compare your experience as well as the performance between each type of broker.
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