In this article you will learn:
- How Forex Brokers make money?
- Which Forex Brokers make money against the trader
- What are Dealing Desk and no Dealing Desk Brokers
- What are STP Forex Brokers
- What are ECN Forex Brokers
- What are Market Makers
There are a lot of Forex brokers out there.
When browsing the topforexbrokers.reviews and looking at the Forex Brokers Reviews, they may all seem largely the same.
But the truth is that Forex brokers come in different types and the most significant difference between them has to do with how they fill your trade orders and how they make money.
While some brokers operate solely as one type or another, other brokers offer different accounts that operate according to a different model than the other account types, such as an ECN account.
No Dealing Desk (NDD Forex Brokers)
Brokers who do not have a Dealing Desk (NDD Forex Brokers) simply facilitate your orders.
They pass on the order through to the interbank system.
The service they provide is giving you access to the interbank system.
This is service is not for free!!! You are paying the Spread[/ft_boxes]
Since they are just a medium, you are just using them to trade, not actually trading against them.
Unlike a market maker broker, who may assume the counterparty to your trades if no other orders can be matched, brokers with no dealing desk have no vested interest in your failure at any time.
There are two types of No Dealing Desk brokers. The difference in the two lies in how they route orders.
Straight-Through Processing (STP)
The straight-through processing model is a cross between the lower capital requirements and higher leverages of a market maker and the direct interbank access of an ECN. This allows brokers to get around some of the limitations that come with trading in an exclusively ECN environment. Brokers who use the straight-through processing model direct the orders of their clients directly with liquidity providers such as banks and larger brokers. These institutions direct the orders to the interbank system. Since the bid/ask spread provided by the liquidity providers is variable, STP brokers tend to have variable spreads as well. STP brokers fully computerize their transactions and no intervention is made by any broker.
STPs Reflect the Rates of the Actual Forex Market
Since the client is given direct access to the interbank system, the Forex rates reflect the actual Forex market rates. The STP adds its own bid/ask spread to the spread provided by the liquidity providers. These spreads are usually variable because the spreads provided by the different liquidity providers differ.
Volatility is Good for Scalping
This direct access to the Forex market yields more volatility, which is optimal for the success use of scalping strategies. In a market maker brokerage, the true volatility in the market is somewhat muted by the fact that brokerage sets its own prices. Market makers typically ban scalping in any case, but STPs generally allow it since, as they are not direct counterparties to your trades, they do not have a conflict of interest.
STP Trading Platforms Generally More Complex Than That of Market Makers
STP trading platforms are generally complex. They are not designed for the novice trader or even the retail trader for that matter. This is because STPs generally cater to more experienced traders.
An STP Sometimes Takes on the Role of Counterparty in a Trade
Sometimes if a counterparty for a trader can’t be found in the interbank system, the STP broker will take on the role of the counterparty to the trade, like the market maker. But unlike a market maker, the STP broker is completely automated and the counterparty role is handled in a different way that doesn’t present any conflict of interest. When an STP does this depends upon the broker—some use complex algorithms to decide when trading against you would be profitable for them. Some consider STP brokers optimal in that they combine the control over the market that a marker maker has with the direct access to the interbank system that an ECN has.
Some Market Makers Call Themselves STPs
STP is a term without any legal meaning, so it is common for many market makers to claim to be STPs, when in fact they are not. When these marker makers who claim to be STPs become counterparty in a trade against you, they really do benefit from your loss. This presents a conflict of interest.
Most trades in an STP model will be filled through the interbank market. This means that swap fees will be incurred. Thus, rollover fees will be charged if a position is kept open overnight.
Electronic Communication Network (ECN)
ECN brokers direct traders with counterparties in the interbank market. ECNs have no inventory and have no control over the price of currency pairs, since the only role they play is in the connection of buyers and sellers with the interbank market. ECNs either charge spreads on top of the bid/ask spreads of the interbank market or charge fixed trade commissions. This is how ECNs make their money.
ECNs Demand Higher Capital Requirements; Orders Can Be Re-Quoted and Rejected
Perhaps you’ve noticed that ECNs or ECN accounts require more capital and higher minimum deposits. This is due to the fact that the financial institutions that ECNs connect to in the interbank market trade in very large lots. Unlike with STPs and Market makers who can enter the counterparty end of a trade if no other counterparty is found, orders can be re-quoted or rejected altogether when no counterparty is found on the interbank market. This type of situation where it is difficult to match buyers and sellers, is known as low market liquidity.
ECNs Use Dynamic Spreads to Stay Ahead of the Variable Spreads in the Interbank Market
ECN brokers offer the tightest spreads available and their prices more closely resemble those of the larger Forex market because they provide a direct connection to banks, hedge funds, traders and brokers all competing against each other to provide the best bid/ask prices. Since the different institutions of the interbank market offer different rates, this means that ECN brokers use dynamic spreads to ensure that they profit.
ECNs Also Feature Volatility Favorable to Scalping; ECN Platforms Hard for Average Traders
Since you have a direct connection to the interbank market, the full volatility of the Forex market is revealed to you. This makes scalping strategies more applicable. In contrast, many market makers ban this activity.
High-volume Capacity of ECNs Favor Those Who Use Trading Robots
With its high-volume capabilities, traders who use Expert Advisors or other trading robots will find ECN extremely compatible with their trading needs. The ECNs direct connection to liquidity providers and other participants in the Forex market means that orders can be carried out with an optimum of speed.
ECN Platforms Not as User Friendly as Those of Market Makers
Like STP brokers, the platforms provided by STP brokers are generally hard to use for the average trader. This is because ECNs typically lack the emphasis on them that maker makers have. They instead focus on delivering tight spreads and providing the capabilities to trade at higher volumes.
ECNs Offer Lower Margin Due to High Capital Requirements
ECNs require a high amount of capital to be on hand. Thus, ECNs cannot generally provide as much margin as other broker types.
ECNs Don’t Want You to Fail
Like STP brokers, since ECNs are never the counterparty to your trades, they have no vested interest in seeing you lose. In fact, they are more likely to want you to succeed, as this means that you will trade more with them and they will benefit from your spreads and commissions. This, in addition to the fact that the ECN is just a conduit to the interbank market, means that the ECN won’t be manipulating prices in order to take out your stop-loss levels just to benefit themselves, as has been the case with some market maker brokers.
Since ECN orders are filled through the interbank market, swap fees will be in effect. This means that rollover fees will be charged.
Once upon a time, there were literal people who sat at literal desks and managed the investments of a financial institution. These people and the desk they sat at was called the “dealing desk.” Today, the term is used to referred to a firm’s traders who manage the portfolio and hedging of the firm.
Brokers with this type of setup have the power to set their own prices.
Market Makers Take on the Role of Counterparty to Your Trades If No Counterparty Can Be Found
Because they enable trading by matching the buy orders of clients who want to buy and the sell orders of clients who want to sell, these brokers make a market and are called market makers. When these brokers can’t find sellers to match buyers or vice versa, they sometimes take on the role of counterparty to their clients’ trades.
Market Maker (MM)
Since market makers truly do “make the market,” they have more control over it and can offer faster execution, higher leverages, fixed spreads and no commissions. If you are a novice trader and want to trade in smaller lot sizes, then a market maker may be a perfect fit for your trading needs. However, since the market maker is a closed system, prices may differ from those found on the interbank system.
Market Makers Lure Beginners with Simpler Interfaces and Fancier Analytics Tools
Market makers also tend to target more inexperienced Forex traders and put a lot of effort into providing very user-friendly trading platform software and analysis tools. They provide streaming news and fancy charts that are easy to navigate and understand. These are by no means bad, but they are part of the attempt to attract less experienced investors.
Market Makers Can Suffer from Low Liquidity When They Can’t Find Counterparties and Don’t Want to Be One
The market maker has only itself and other traders to build orders from. So, there may be incidents of low liquidity if there are no sellers to match buy orders or vice versa, and the firm itself is unwilling to step in and assume the role of counterparty to the trade.
Negative Balance Protection
Many market makers offer something they call negative balance protection, in which case if the market gaps (say, over a weekend or during an extremely strong news event) and your stop-loss orders are not executed, this could leave you with a massive loss that wipes out your account and then some. In this case your account balance will be zeroed out and the negative balance will not be held against you.
Restrictions on Scalping and Automated Trading
Many market makers place restrictions on scalping and automated trading. The banning of scalping is an almost sure sign that you are dealing with a market maker. This is because market makers are generally the counterparty to such trades and if scalping strategies are used effectively, they will be on the losing end of them.
Market makers have also been known to spike prices on their platforms in order to seek out your stop orders to benefit themselves. It is hard to tell whether these claims are legitimate as oftentimes, market makers appeal to beginning Forex traders, who also happen to be the most inexperienced and worst traders.
It is difficult to determine whether the traders have actually been scammed or if they were just that bad at trading.
No Rollover Fees
Since market makers are the market, no money actually moves into the interbank Forex markets. This means that there are no swap fees to be paid. So, if positions are kept open overnight, no rollover fees are charged.
There are many different types of Forex broker.
While the market makers may appeal to those who want fast execution, more leverage and smaller lot sizes, traders who specialize in automating trades and those who utilize high frequency or scalping strategies, will find themselves better satisfied with an ECN or STP broker.
Understanding the different types of brokers will prepare you to choose the right broker for your financial needs and give you a firm foundation upon which to build your trading success.
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