Forex Trading was very hard in the initial years. When the market first opened up in the 1990s, there were no brokers in the market. Even to make the initial entry, you needed a lot of money. Then, the CFTC was created which was a government regulator.
It was started with the aim of providing security to the traders and put in action the ‘Commodity Exchange Act and the Commodity Futures Modernization Act’ that opened up new opportunities. The new acts helped the emergence of a new set of players, the Forex brokers.
Soon after this, there was a sudden surge in the presence of Forex brokers. They started appearing everywhere in the market. The advent of these new players shaped the retail forex market into its present form.
Today, there is no shortage of Forex brokers. You can get a wide variety of choices and types of brokers in the market.
The choices are so many, a novice might easily get confused by them. In fact, amateur traders often make the wrong choices when it comes to choosing a broker.
This is why, in the present chapter, I will tell you everything you need to know about Forex brokers, ranging from their types to the benefits and drawbacks each have with the hope that you will come out of the other end of the chapter more knowledgeable and be able to make more informed decisions with your money.
“Dealing desk” is be a common term that you might have come across while looking for a potential broker. The first thing you need to know about finding a Forex broker is that they will either have a “dealing desk” or “no dealing desk”.
These are the two primary categories and every broker will fall under either one of the categories. The decision of choosing the right Forex broker will be determined by the style of trade that you endeavor to engage in.
The brokers who conduct their business from a dealing desk are known as the market makers. These kinds of brokers earn their profit through the spread which is a kind of commission they levy on the bid price. The difference between the bid price and the ask price is known as the spread.
It is these brokers who create the trading market for the clients where the retail traders can conduct the trading activities.
Suppose a retail trader who is a client of the broker places a trading order, the broker would first look at his other clients to see if he can find a buyer. This process is the most profitable to the broker because either way, he would make a profit from both the clients through the spread.
This is the most ideal scenario for any Forex broker.
However, if the broker is unsuccessful in matching the orders with his own clients, he will open an opposing position in the Forex market, a process known as hedging. This is done to safeguard him against any losses that his client’s trade might invite.
For instance, if the trade position that you had opened fails to bring any profit, the hedge trade will make sure that the broker does not suffer any losses.
On the contrary, if your trade position fetches good profits, the broker will earn commission from that which will compensate for any losses that he suffers in his hedge trade.
Benefits of Dealing Desk Brokers
The Spreads are Fixed
The brokers with a dealing desk often have an aggressive spread since because it is their sole way to earn a commission out of your trading positions. The difference between the Bid and the Ask prices is how the brokers with dealing desks earn money.
However, there is a lot of fierce competition between the different Forex brokers due to which the spreads are quite inexpensive.
In fact, the rates of the spreads are so low that you seldom ever notice it, unless and until you engage in high-frequency trading.
Fixed spreads are perfect for swing traders who prefer to keep their trading positions open for a longer term.
Most of the retail traders do not mind the spreads because they fade in significance compared to the profit the traders earn from their trading. However, scalpers and day traders try to look for Forex brokers who have even cheaper rates for their spreads to maximize their own profit.
Drawbacks of the Dealing Desk Brokers
You are Unaware of the Bid Prices
The dealing desk brokers will only tell you their Ask price which is always higher than the real market price quotes or what is known as the Bid price. You would be completely in dark about the actual interbank network quotes which are usually much cheaper.
You have no idea about the real market scenario and only get to see what the broker shows you.
This leaves a possibility of foul play on the part of the broker where he can increase the Ask prices exponentially for his own benefit and you would have no idea about it.
The term “stop hunting” denotes a situation where a broker selfishly manipulates the prices in your order to make you stop your trade prematurely. Unregulated Forex brokers can easily get away with these sort of manipulations with the prices.
These immoral brokers are excellent at understanding the psyche of their clients and know that most traders are driven by an innate need to be always in the trade. So, when your trades are stopped out, it impels you to open more trading positions, thus profiting these brokers.
When you pick a dealing desk broker, they have access to all your trading data including where you have set your stop loss. However, once they have this information in their hand, they can use it to their own selfish ends. By manually changing the price feeds in the software of the clients, these unethical brokers strive to wipe out or “trigger” all the stop losses that you have set.
This immoral tactic is beneficial to the broker as the traders have a need to stay in the market. So, most probably, the trader would again open a position and enter a Forex trade instantly.
The profits of the broker depend on how much volume of trade their clients invest in. Every new position that you open in the forex market implies a new opportunity for the broker to benefit through the spreads that they create.
This way, the Forex brokers do not have to worry about whether your trade runs a profit or a loss because anyway, they will earn their share in terms of the spread. In fact, the more trades you enter in a day, the more they profit.
Mostly unregulated brokers engage in the evil practice of stop hunting. Regulated brokers do not engage in such immoral practices such as stop hunting in the fear of being fined heavily or the danger of losing their broker’s license altogether.
When you are contacting a potential dealing desk broker, it is always advisable to ensure that he is regulated by an authorized government body to prevent any potential foul play.
Suppose the dealing desk is incapable of finding a match for your trade, in that case, you are likely to receive a price re-quote which will be displayed on your trading screen. This will depend on the policies of the dealing desks. The price re-quotes will be absorbed by some Forex brokers who would still honor the price requests that were made originally.
You have the choice of opting or rejecting a price re-quote when it is passed on to you.
When the market is in a volatile condition, you can expect to get a number of price re-quotes in rapid succession. This happens because the market moves at a rapid speed and the dealing desk cannot keep up with it.
However, once the hysteria of the price re-quotes end, often times you would find that your trade is at an unsatisfactory and lower price.
No Dealing desk Brokers
As the name suggests, these kinds of brokers do not operate from a dealing desk. Instead of that, these brokers act as channels or bridges via whom you can connect your trade to another party. NDD brokers act the same way as your Internet Service Providers, Just like your ISP connects you to the rest of the internet, the NDD brokers connect you to another trading party.
NDD brokers are further divided into two main subtypes:
- Straight through Processor (STP)
- Electronic Communications network Broker (ECN)
The straight Through Processor
Non-dealing desk STP brokers possess a straight-through processing system which gives them direct access to the interbank network through the big banks that provide them liquidity.
The straight through processing system gives you the opportunity to buy at a low price and sell at a high price. In this system, one can find the most inexpensive ask quotes and the highest bid quotes.
However, you will not have an access to these prices. The STP brokers add their own spread commission to the prices and then present them to you. This is how the STP brokers earn their share of profits.
Benefits of Opting for an STP Broker
You can find cheaper spread rate from Non-dealing desk STP brokers compared to a dealing desk broker primarily due to the fact that they always get the best pricing from the interbank network.
This is a golden opportunity for anyone who opens short-term trading positions like those who opt for scalping and day trading strategies.
Drawbacks of an STP Broker
Unlike the dealing desk brokers, Non-dealing desk brokers do not have a fixed spread. Due to the fact that the interbank price quotes are subject to constant changes, this also influences the bid and ask price of the STP brokers.
Usually the spreads fluctuate around a central point, however, if there are any huge upheaval in the market due to any major economic or political news, it can cause the spreads to fluctuate over a larger range.
For instance, a Non-Farm Payroll forecast can increase or decrease the spreads up to 10-20 pips! If you dwell in scalping or you trade the news, you need a specific kind of a broker. In such cases, STP brokers are not your best option since the spreads vary too rapidly. The spreads may become a little too expensive when you need to place your trade order.
However, trading news releases can often be a suicidal mission. Read my article: Should You Be Trading the Forex News to learn more about the topic.
Although the rapidly fluctuating nature of the Forex market during a major news release can seem attractive at the first glance, it is definitely not a wise way to trade in the Forex Market.
The Electronic Communications Network Broker (ECN Broker)
The ECN broker appears as an immediate passageway to the Electronic Communications Network, which associates you specifically with different members on the ECN.
The various other traders of the Forex market that you get connected to include large banks, hedge funds and investment managers, big commercial companies and other brokers as well.
There are a few brokers who claim to be genuine ECN brokers to pick up the showcasing edge, however, in reality, are simply STP representatives.
Focal points of an ECN Broker
Unlike some other other brokers, ECN brokers provide the best bid and ask prices. They do not manipulate the market prices and present to your quotes directly from the interbank network.
Since the ECN broker does not manipulate the prices, as a trader, you only need to pay the spread which is the difference between the best bid and the best ask price at that point of time. A few times, it so happens that the spread amounts to nearly zero.
The exchange execution time is reduced exponentially due to the simple fact that you are trading with the interbank network directly. You are not making the trade via a broker. This essentially helps to negate the “middleman” which is the broker in this case.
Stable spreads amid news and occasions.
Typically a broker’s spread will extend to the point that it’s far too costly, making it impossible to exchange amid high unpredictability news releases and global events. With ECN dealers, what you see is the thing that you get. This can be indispensable for news traders, as they can get in and out of exchanges without worrying about increasing spreads.
ECN brokers offer an element called depth of market which enables you to ‘see’ the liquidity of the market at various value quotes.
Drawbacks of an ECN Broker
Since ECN brokers don’t control the spread costs that are cited, they require another method for producing benefit. They do this by charging you a commission for opening the exchange.
The commission cost is typically computed by the volume of your dealer arrange, or at the end of the day, per standard lot.
When it comes to choosing a Forex broker, the options are limitless. Their mode of operation for handling your trades vary from each other.
To be honest, the choice of the most appropriate Forex trader depends on your Forex trading strategies and the style of trading. These are the primary factors that go into the blend when choosing the best Forex Trader for yourself.
It is important to make sure that the broker you are choosing to work with is regulated. Regulators make sure to safeguard you against potential foul play by any unregulated Forex broker, the instances of which are plenty in the Forex Market.
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