homepage_name! > Editions > Number 039 > Forex Brokers
Forex Brokers
The Foreign Exchange market (Forex, FX, or currency market) has become a global, worldwide decentralized over-the-counter financial market for trading currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends.
The foreign exchange market began forming during the 1970s when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.In those days only banks and wealthy people could benefit from the currency exchange. Due to modern day technology and leverage it has become available to the retail market.
The foreign exchange market is unique& attractive because of:
• its huge trading volumes, leading to high liquidity;
• its geographical dispersion; you can trade anywhere you have internet connection
• its continuous operation: 24 hours a day except weekends, i.e. trading from 20:15 GMT on Sunday until 22:00 GMT Friday;
• the variety of factors that affect exchange rates;
• the low margins of relative profit compared with other markets of fixed income; and
• the use of leverage to enhance profit margins with respect to account size.
In regards to the Forex market participants, unlike a stock market, the foreign exchange market is divided into levels of access. At the top is the inter-bank market, which is made up of the largest commercial banks and securities dealers. Within the inter-bank market, spreads, which are the difference between the bid and ask prices, are razor sharp and not known to players outside the inner circle. The difference between the bid and ask prices widens (for example from 0-1 pip to 1-2 pips for a currencies such as the EUR) as you go down the levels of access. This is due to volume. If a trader can guarantee large numbers of transactions for large amounts, they can demand a smaller difference between the bid and ask price, which is referred to as a better spread.
The levels of access that make up the foreign exchange market are determined by the size of the „line“ (the amount of money with which they are trading). The top-tier interbank market accounts for 53% of all transactions. After that there are usually smaller banks, followed by large multi-national corporations (which need to hedge risk and pay employees in different countries), large hedge funds, and even some of the retail FX market makers. Central banks also participate in the foreign exchange market to align currencies to their economic needs.
The Different Categories of Forex Brokers: NDD vs. DDvs. ECN vs. STP vs. MM:
As a retail investor, one has a lot of choices when deciding which broker to work with. Most of them offer excessive leverage, fixed or variable spreads and demo accounts. But what differentiates one brokerage to another is sometimes hard to spot, and most of the times a retail Forex company acts as the market maker for all your trades.
The consequences of that are shading of prices, widen spreads arbitrarily, or trade against the client!
Ever wanted to understand the difference between a Dealing Desk (DD), No Dealing Desk (NDD), Straight Through Processing (STP), Market Maker (MM), and Electronic Communications Network (ECN) ? Then this article should answer most of your questions and will guide you how to selectthe right broker when trading Forex, Commodities or CFDs’ with leverage.
DD — Dealing Desk — Forex brokers that operate (route orders) through the Dealing Desk and quote fixed spreads. A dealing desk broker makes money via spreads and by trading against its clients. A Dealing Desk Forex broker is called a Market Maker - they literally „make the market“ for traders: when traders want to sell, they buy from them , when traders want to buy, they sell to them, e.g. they will always take the opposite side of the trade and in this way „create the market“. A trader doesn’t see the real market quotes, which allows Dealing Desk brokers (Market Makers) manipulate with their quotes where they need to in order to fill clients orders.
NDD — No Dealing Desk — NDD Forex brokers provide access to the interbank market without passing orders through the dealing desk. With true No Dealing Desk brokers there are no re-quotes on orders and no additional pausing during order confirmation. This, in particular, allows trading during news times with no restrictions on trading.
An NDD broker can either charge commission for trading or choose to increase the spread and make Forex trading commission free.
No Dealing Desk brokers are STP or ECN+STP.
STP Brokers — Straight Through Processing display its own quotes which are correlated to the actual inter-banking quotes and send orders directly from clients to the liquidity providers - banks or other brokers. Sometimes STP brokers have just one liquidity provider, other times several. The more liquidity providers there are and therefore liquidity in the system, the better the fills for the clients. The fact that traders have access to the real-time market quotes and can execute trades immediately without dealer intervention is what makes the platform STP.
ECN — Electronic Communications Network — ECN Forex brokers additionally allow clients’ orders to interact with other clients’ orders. ECN Forex broker provides a marketplace where all its participants (banks, market makers and individual traders) trade against each other by sending competing bids and offers into the system. Participants interact inside the system and get the best offers for their trades available at that time. All trading orders are matched between counter parties in real time. A small trading fee - commission - is always applied. Recently one tried to cover this gap by offering a MT4 ECN platform, not very successfully or transparently in my opinion.
A Market Maker (MM) is a firm that both buys the clients lots and sells to the client. This is also called a Dealing Desk (DD) firm.
Your orders are never quoted on the market, simply because the Broker IS the market. When you read about brokers ‘trading against you’ this is what people actually mean, although they are partly wrong – brokers don’t necessarily ‘trade against you’, they are simply the counterparty to your trades.
Of course they have an obvious interest for you to lose money but when people go out and point at brokers saying they steal your money or trade against you most of the time this only serves for marketing purposes and as a promotion for other ‘non market making’ brokers.
Market Makers also typically never re-quote orders because they don’t need to route your orders to the inter-banking market but choose whether to accept your orders or not.
For instance when too many traders place orders on one currency pair and in the same direction long or short, the market maker might not want to take all this risk and can reject some orders.
The same can happen when there is ‘news time’ and MM’s exposure peaks beyond certain predefined levels.
A ForexBroker who is not a Market Maker, either is a Straight Through Processing Broker (STP) or an Electronic Communications Network Broker (ECN). These types of brokers are typically called Non Dealing Desk brokers.
Sometimes STP brokers are discussed as if they were ECN brokers. To be a true ECN, a broker must display the Depth of the Market (DOM) in a data window, let clients show their own order size in the system and allow other clients to hit those orders. With ECN broker traders can see where the liquidity is and execute trades.
ECN brokers are the purest breed among all Forex dealers. They don’t profit on spread difference. Their only profit comes from commission. ECN brokers are interested in their clients to be winning; otherwise there will be no commission to earn.
STP brokers make money on spreads, thus even though they do not have a physical dealing desk to monitor and counter-trade client orders, they are still able to set their own price - the spread markup - for routing trading orders to liquidity providers and providing their clients with advanced trading services, lower account deposits, faster execution and anonymous trading environment with no dealing desk.
STP brokers also have a strong interest to see their clients trading profitable, so that clients can also increase their trade sizes, resulting in greater earnings for the broker.
Market makers make money on spreads and by hedging against their clients. Since Market Makers profit from their clients’ losses and vice versa, one could derive clearly that there is an inherit conflict of interest between the MM and its clients.
Furthermore, clients’ profitability increases the MM’s exposure, which eventually could lead to the default of the MM.
Benefits of trading with No Dealing Desk brokers
Among the main reason why traders look for NDD brokers is transparency, better and faster fills and anonymity. Transparency means that a trader enters a true market instead of the market being artificially created for him. Better fills are a result of the direct and competitive market bids and offers.
Anonymity means that there is no Dealing Desk watching who has come to the market and is asking for an order to be filled, instead client orders are executed automatically, immediately through the market network and totally anonymously.
On the opposite side is a Dealing Desk broker, who is able to profile their clients. In the worst case scenario, such a broker can split clients into groups and put less successful ones on auto-execution and trade against them because on average they will lose, while clients that show signs of successful trading will be put on „slow-down“ mode and can be provided with frequent re-quotes, slippage and/or slower execution especially during fast moving markets while a broker tries to offset own risks.
The transparency of a Dealing Desk broker depends on the rules inside the company.
Hopefully, this article can help you identify some of the challenges and aspects when choosing a Forex broker.
The foreign exchange market began forming during the 1970s when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.In those days only banks and wealthy people could benefit from the currency exchange. Due to modern day technology and leverage it has become available to the retail market.
The foreign exchange market is unique& attractive because of:
• its huge trading volumes, leading to high liquidity;
• its geographical dispersion; you can trade anywhere you have internet connection
• its continuous operation: 24 hours a day except weekends, i.e. trading from 20:15 GMT on Sunday until 22:00 GMT Friday;
• the variety of factors that affect exchange rates;
• the low margins of relative profit compared with other markets of fixed income; and
• the use of leverage to enhance profit margins with respect to account size.
In regards to the Forex market participants, unlike a stock market, the foreign exchange market is divided into levels of access. At the top is the inter-bank market, which is made up of the largest commercial banks and securities dealers. Within the inter-bank market, spreads, which are the difference between the bid and ask prices, are razor sharp and not known to players outside the inner circle. The difference between the bid and ask prices widens (for example from 0-1 pip to 1-2 pips for a currencies such as the EUR) as you go down the levels of access. This is due to volume. If a trader can guarantee large numbers of transactions for large amounts, they can demand a smaller difference between the bid and ask price, which is referred to as a better spread.
The levels of access that make up the foreign exchange market are determined by the size of the „line“ (the amount of money with which they are trading). The top-tier interbank market accounts for 53% of all transactions. After that there are usually smaller banks, followed by large multi-national corporations (which need to hedge risk and pay employees in different countries), large hedge funds, and even some of the retail FX market makers. Central banks also participate in the foreign exchange market to align currencies to their economic needs.
The Different Categories of Forex Brokers: NDD vs. DDvs. ECN vs. STP vs. MM:
As a retail investor, one has a lot of choices when deciding which broker to work with. Most of them offer excessive leverage, fixed or variable spreads and demo accounts. But what differentiates one brokerage to another is sometimes hard to spot, and most of the times a retail Forex company acts as the market maker for all your trades.
The consequences of that are shading of prices, widen spreads arbitrarily, or trade against the client!
Ever wanted to understand the difference between a Dealing Desk (DD), No Dealing Desk (NDD), Straight Through Processing (STP), Market Maker (MM), and Electronic Communications Network (ECN) ? Then this article should answer most of your questions and will guide you how to selectthe right broker when trading Forex, Commodities or CFDs’ with leverage.
DD — Dealing Desk — Forex brokers that operate (route orders) through the Dealing Desk and quote fixed spreads. A dealing desk broker makes money via spreads and by trading against its clients. A Dealing Desk Forex broker is called a Market Maker - they literally „make the market“ for traders: when traders want to sell, they buy from them , when traders want to buy, they sell to them, e.g. they will always take the opposite side of the trade and in this way „create the market“. A trader doesn’t see the real market quotes, which allows Dealing Desk brokers (Market Makers) manipulate with their quotes where they need to in order to fill clients orders.
NDD — No Dealing Desk — NDD Forex brokers provide access to the interbank market without passing orders through the dealing desk. With true No Dealing Desk brokers there are no re-quotes on orders and no additional pausing during order confirmation. This, in particular, allows trading during news times with no restrictions on trading.
An NDD broker can either charge commission for trading or choose to increase the spread and make Forex trading commission free.
No Dealing Desk brokers are STP or ECN+STP.
STP Brokers — Straight Through Processing display its own quotes which are correlated to the actual inter-banking quotes and send orders directly from clients to the liquidity providers - banks or other brokers. Sometimes STP brokers have just one liquidity provider, other times several. The more liquidity providers there are and therefore liquidity in the system, the better the fills for the clients. The fact that traders have access to the real-time market quotes and can execute trades immediately without dealer intervention is what makes the platform STP.
ECN — Electronic Communications Network — ECN Forex brokers additionally allow clients’ orders to interact with other clients’ orders. ECN Forex broker provides a marketplace where all its participants (banks, market makers and individual traders) trade against each other by sending competing bids and offers into the system. Participants interact inside the system and get the best offers for their trades available at that time. All trading orders are matched between counter parties in real time. A small trading fee - commission - is always applied. Recently one tried to cover this gap by offering a MT4 ECN platform, not very successfully or transparently in my opinion.
A Market Maker (MM) is a firm that both buys the clients lots and sells to the client. This is also called a Dealing Desk (DD) firm.
Your orders are never quoted on the market, simply because the Broker IS the market. When you read about brokers ‘trading against you’ this is what people actually mean, although they are partly wrong – brokers don’t necessarily ‘trade against you’, they are simply the counterparty to your trades.
Of course they have an obvious interest for you to lose money but when people go out and point at brokers saying they steal your money or trade against you most of the time this only serves for marketing purposes and as a promotion for other ‘non market making’ brokers.
Market Makers also typically never re-quote orders because they don’t need to route your orders to the inter-banking market but choose whether to accept your orders or not.
For instance when too many traders place orders on one currency pair and in the same direction long or short, the market maker might not want to take all this risk and can reject some orders.
The same can happen when there is ‘news time’ and MM’s exposure peaks beyond certain predefined levels.
A ForexBroker who is not a Market Maker, either is a Straight Through Processing Broker (STP) or an Electronic Communications Network Broker (ECN). These types of brokers are typically called Non Dealing Desk brokers.
Sometimes STP brokers are discussed as if they were ECN brokers. To be a true ECN, a broker must display the Depth of the Market (DOM) in a data window, let clients show their own order size in the system and allow other clients to hit those orders. With ECN broker traders can see where the liquidity is and execute trades.
ECN brokers are the purest breed among all Forex dealers. They don’t profit on spread difference. Their only profit comes from commission. ECN brokers are interested in their clients to be winning; otherwise there will be no commission to earn.
STP brokers make money on spreads, thus even though they do not have a physical dealing desk to monitor and counter-trade client orders, they are still able to set their own price - the spread markup - for routing trading orders to liquidity providers and providing their clients with advanced trading services, lower account deposits, faster execution and anonymous trading environment with no dealing desk.
STP brokers also have a strong interest to see their clients trading profitable, so that clients can also increase their trade sizes, resulting in greater earnings for the broker.
Market makers make money on spreads and by hedging against their clients. Since Market Makers profit from their clients’ losses and vice versa, one could derive clearly that there is an inherit conflict of interest between the MM and its clients.
Furthermore, clients’ profitability increases the MM’s exposure, which eventually could lead to the default of the MM.
Benefits of trading with No Dealing Desk brokers
Among the main reason why traders look for NDD brokers is transparency, better and faster fills and anonymity. Transparency means that a trader enters a true market instead of the market being artificially created for him. Better fills are a result of the direct and competitive market bids and offers.
Anonymity means that there is no Dealing Desk watching who has come to the market and is asking for an order to be filled, instead client orders are executed automatically, immediately through the market network and totally anonymously.
On the opposite side is a Dealing Desk broker, who is able to profile their clients. In the worst case scenario, such a broker can split clients into groups and put less successful ones on auto-execution and trade against them because on average they will lose, while clients that show signs of successful trading will be put on „slow-down“ mode and can be provided with frequent re-quotes, slippage and/or slower execution especially during fast moving markets while a broker tries to offset own risks.
The transparency of a Dealing Desk broker depends on the rules inside the company.
Hopefully, this article can help you identify some of the challenges and aspects when choosing a Forex broker.
