You might already be excited to start trading, but it’s important to remember that choosing the right broker can be important. You will want to have a broker that can fit for your particular needs. The same way that you choose anything – a doctor or lawyer for example – you want to ensure that your broker is not only qualified, but that you fit with them personality-wise, as well. The last thing that you want is to have a bad relationship with the person that is supposed to be helping you build your wealth. This can affect your mindset, trading, and ultimately, your quality of life, if you are not careful.
Online forex brokers have truly allowed the market to thrive, and have allowed the entire forex market to not just be one big game run by institutional money. The internet has helped to democratize the entire market, which has allowed people to actually develop their trading skills, instead of the same big banks and governments getting rich off of currencies.
There are now countless online forex retail brokers, but it is important to note that choosing the right one can be essential. You want to be able to distinguish between the better options, and the more nefarious ones, which can be trickier than expected. Of course, a sketchy online forex broker will not outright tell you that their practices are sketchy, will they?
Dealing Desk or No Dealing Desk forex brokers
There are two main types of brokers: dealing desk brokers (fixed spread) and no dealing desk brokers (ECN model). This can further be divided into more categories, but this original division is important. Now stay with me here…
No Dealing desk brokers are also divided into categories such as straight through processing, electronic communication network and straight through processing. These terms are often identified by the acronyms ECN and STP.
Now, dealing desk brokers are “market makers”, which we established often take the other side of a client’s trade. They help to provide liquidity, and create a market.
You might be thinking, Wait, so they are betting against me? Doesn’t that mean that they don’t want me to make money? Why would I sign up with a broker like that, wouldn’t that be a complete conflict of interest?
The truth is that it really isn’t. Market makers are busy filling orders on both sides for clients, and survive by essentially creating a market. They aren’t really looking for one result either way (most of the time).
There is less risk for them to set fixed spreads, which is a good thing for you, and also – their rates are so close to the banks’ interexchange rates, because they have to be. The fact of the matter is that with all of the new online retail brokers, the competition is so close that they have to make it so close to the bank rate – otherwise the consumer will go elsewhere. This is obviously great for you as well, in terms of your trading.
Trading with a Dealing Desk Broker:
Here’s how it might work, just to give you an idea. You place a buy order for 100,000 EUR/USD units with your broker. They find a matching sell order to make the trade happen, and here’s how they do that. First, it could be by someone who is already a client of theirs. Essentially, one client has sold to another client. If this can’t happen, they also have ways to pass on the trade to a liquidity provider to ensure it happens, because after all, if they cannot make your trade happen, they certainly won’t be in business for very long, will they?
The only time they are FORCED to take the opposite side of your trade, is if they cannot find a match, which will likely be a rarity.
Regardless, they earn through the spread regardless, so it is important to realize that the broker is not some scheming entity trying to take money from you. This might be essential to those who might be a little more paranoid with their money, or more prone to conspiracy theories.
However, brokers DO have different ways of managing risk, and it might not hurt to explore THAT side of things.
Trading with a Non Dealing Desk Broker:
There is no dealing desk involved whatsoever, but here – the broker simply matches your trade with someone else. Voila!
They might charge a commission, or might put up a small spread, but either way – they make things happen for you, and they do this either through STP or STP+ECN.
Straight Through Processing means that the broker uses liquidity providers, who have their own bid and ask price, and the broker makes your trade happen this way. Now, even liquidity providers have their OWN competition, so the broker might see three different bid/ask prices, and choose to go with one specific provider.
In this manner, everything is somewhat regulated, even if the entire market is free – the competition reigns everything in so rates and fees don’t get out of control. This is great for you, the trader!
Of course, the broker isn’t going to go through the trouble of doing all of this for free. How would they stay in business? Essentially, they mark up the fees that the liquidity provider has, so you will end up paying some comission while typically keeping the interbank spreads.
That’s usually how STP works, through variable spreads. No matter what the size of your trade, the STP broker actually earns comission revenue no matter how you choose to trade. In this manner, they are paid for their service.
ECN forex brokers have an entire network where your trade interacts with all sorts of other traders in the market. This means that other brokers, hedge funds, banks, and other participants are all involved, trading away.
This also allows the client to see the true depth of market, which can give more insight into how the market truly is moving, which might help the trader theorize or strategize on a whole different level. Of course, this all depends on how deeply one decides to look into the market, or what exactly their strategy is. This certainly might not matter to those who are playing with smaller amounts of money, or simply day trading for a quick profit before they are off to lunch. ECN brokers are usually compensated by commission, rather than any other manner.