TYPES OF FOREX BROKER
The retail forex market has evolved quickly over the last few years in part due to the rapid growth of its customer base that
has, in turn, led to aggressive competition among those serving the industry. As a consequence, several different types of
forex brokers have emerged, each differentiated primarily by the way that trade execution is processed.
FOREX BROKER WITH DEALING DESK (DD)
This forex broker also acts as a counterparty to the customer through their trading or dealing desk (DD). The forex
broker or dealer is also called a market maker since customers wanting to sell, buy from the forex broker and
customers wanting to buy, sell to the forex broker. In this sense, the forex broker takes the opposite side of every trade
with a customer. While the customer has the benefit of consistency in terms of market availability, the customer does not see
quotes from other counterparties and therefore does not know if the quoted prices differ from those of the interbank market.
STRAIGHT-THROUGH-PROCESSING (STP) FOREX BROKER
A straight-through-processing (STP) forex broker is one that does not have a dealing desk but instead passes
through customer buy and sell orders directly to one or several third parties of the interbank market who become the
counterparty to the customer's trade. In general, the greater the number of third-party participants, the better will
be the liquidity and pricing to the customer.
ELECTRONIC COMMUNICATIONS NETWORK (ECN) FOREX BROKER
Electronic communications network (ECN) forex brokers are straight-through-processing brokers that, in addition
to routing customer orders to the interbank market for execution, will also allow their other customers to be the
counterparty to a transaction. In essence, the ECN forex broker provides
a marketplace
where all of its participants (banks, market makers and individual traders) trade against each other by
sending competing bids and offers into the system; the highest bid and lowest offer are shown. Some ECN forex brokers
even display the depth of the market in a data window that shows the order size accompanying the quoted bid or offer.
HOW FOREX BROKERS EARN INCOME
Forex brokers earn income through their own trading activity and through the quotes provided to customers which may be widened
or even shifted from those of the interbank market. STP forex brokers essentially have two ways to earn income:
by increasing or marking up the bid/ask spread (without directional bias) shown to customers or by charging a commission.
ECN forex brokers usually charge commission for trading forex since they earn no income on the bid/ask spread.
In the U.S., regulations require that the forex broker disclose the fee structure to the customer prior to opening an account.
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Dealing Without a Dealing Desk. Among the main reasons why forex traders prefer to not trade with a dealing desk
is transparency, tighter spreads and anonymity. Transparency means that a trader sees prices from the interbank market
rather than those artificially created by the forex broker or dealer. Tighter spreads are a result of the direct and competitive
market bids and offers from various counterparties. Anonymity means that there is no dealing desk watching who has come to the market
and is asking for an order to be filled - a dealing desk that in turn can adjust its quoted bid or ask based on what a customer likely
needs to get done. |
Spreads: Fixed vs Variable. Forex brokers usually quote fixed spreads for the currency pairs offered to customers.
STP forex brokers who take both the bid and ask from the same counterparty in the interbank market usually quote fixed spreads as well, since most
banks and other market makers quote fixed spreads. ECN forex brokers may quote variable spreads since they will quote the best bid and
ask prices and each may come from different counterparties. Which is better is a matter of opinion. For example, a fixed spread makes profit/loss
simulations easier to run since the bid/ask spread which represents a cost of trading can be accurately imputed.
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