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What is Forex Broker? Is a company that provides trades with access to the foreign exchange market which operates as a middleman between traders or investors and the market. A Forex broker maintains the trading infrastructure, trading platforms, price quotes, assets, and order flow. It is a one-stop solution ensuring traders can access the 24/5 Foreign exchange market.
However, instead of just being the middleman between trader and forex market, they are also the middlemen between traders and what is called a liquidity provider.
At first forex trading was available only to institutional players due to the high transaction costs and difficulty to access, it all changed when the Internet and online trading appeared. Forex brokers made it possible for the retail trader to participate to the foreign exchange market.
What is Liquidity provider? Is a market broker or financial institution which behaves as a market maker in a chosen asset class. The liquidity provider acts at both ends of currency transactions that is sells and buys a particular asset at certain prices. The providers buy large volumes of securities from the companies that issue them and then distribute them in batches to financial institutions who then make them available directly to retail investors facilitated by brokers. A bank, financial institution, and trading firm are among the main liquidity provider that serve the market in different ways
The top liquidity providers are called Tier 1 liquidity providers and comprise the largest investment banks with large Forex departments.
Liquidity meaning Is the ability of a currency pair to be traded (bought/sold) on demand. A currency pair is said to have a high level of liquidity when it is easily bought or sold and there is a significant amount of trading activity for that pair. Liquidity is divided into two categories, High liquidity and Low Liquidity.
High Liquidity: Means a currency pair that can be traded (bought/sold) in significant sizes without large variances in its exchange rate–e.g., Major currency pairs such as EUR/USD, GBPUSD Etc.
Low Liquidity: Means a currency pair that cannot be bought/sold in significant sizes without large variances in its exchange rate– e.g., Exotic currency pairs such as USDMXN
There are various types of market participants who provide liquidity. These include central banks, commercial and investment banks, hedge funds, foreign investment managers, Forex brokers, retail traders and high net worth individuals.
Choosing a forex broker could be a challenging task that requires you first to figure out what type of broker you want to trade with. There are two main types of Forex brokers and all types have their own advantages and disadvantages.
Dealing Desk Broker (DD Broker) also called Market Makers, are a type of broker that takes the opposite side of their client’s trades, by fixing the bid and ask price and waiting for a trader who would place an order with their setup. Means if you’re selling a currency pair, they’re buying from you, and vice-versa, your loss is their gain, and their gain is your loss.
They’re called market makers because they’re the main source of liquidity for their traders. Mostly, dealing desk brokers keep your order in-house, within their own liquidity pools and do not execute it to the real forex market.
Advantages to trade with Dealing Desk Broker
Fixed spreads: Dealing desk brokers typically offer fixed spreads, which means that traders know exactly how much they will pay in transaction costs. This can be particularly useful for traders who are operating on a tight budget.
Easy access to liquidity: Since the broker is acting as the counterparty to the trade, they have access to a large pool of liquidity. This means that trades can be executed quickly and at competitive prices.
They don’t charge commission and some offer Nano lot size which may help you to apply proper Risk Management for small trading account.
Disadvantages of Dealing Desk Broker
Slippage: Traders may experience slippage, where the price they receive is different from the price they expected. This can occur when the market moves quickly, and the broker is unable to fill the order at the expected price.
Conflict of interest: Since the broker is acting as the counterparty to the trade, there is a potential conflict of interest. The broker may have an incentive to fill orders at less favorable prices in order to increase their profits.
Lack of transparency: Since the broker is filling the order from their own inventory, there may be limited transparency about the actual market conditions.
Requotes, they may be a delay in filling your order which leads to requotes
No Dealing Desk Broker (NDD Broker) allow customers to trade directly with the interbank rates. NDD brokers send orders directly to the forex market based on market prices that are not determined by them (via liquidity providers, banks, mutual funds, other brokers etc.) NDD brokers act as a bridge between clients and liquidity providers which leads to offer their clients variable spreads with a small mark-up that compensates them for their services and connect two opposite trades placed by two participants and make a bridge between them.
Types of No Dealing Desk Broker
STP Broker, they route your trade orders directly to liquidity providers who have access to real-time interbank market rates once they find the best matching order, they’ll add their spread and fill your order at the external provider’s price + the broker’s spread. You get the best price in the forex market when you trade forex with an STP broker since they have variable spreads.
ECN Broker, allow market participants to trade directly with each other, they are generally the preferred broker style. ECN brokers simply provide a sophisticated network that connects various market participants together, such as hedge funds, banks, other brokers and retail traders. All mentioned market participants trade directly with each other, and the ECN broker charges a small commission for its services. Transparency is achieved by allowing your orders to interact with those of other traders.
ECN + STP, some brokers offer a combination of STP and ECN services. Those brokers are called ECN+STP brokers or Hybrid broker.
Advantages of no Dealing Desk Brokers
The manipulation of market prices is impossible with no dealing desk brokers, which ensures fair and fully transparent trading conditions for their customers.
Orders are filled at a faster speed since they do not go through a dealing desk. Everything is processed automatically by the system which eliminates delay and the need for issuing requotes.
The access to real-time interbank prices prevents the issuing of requotes. This is a common problem among those who use the services of market makers.
The interests of customers and brokers are perfectly aligned because no dealing desk brokers never trade against their clients. Whether your trades win or lose is irrelevant in this case because the broker profits from the commissions it charges. It is actually beneficial for an ECN broker if their clients win money. This enables them to grow their accounts and trade more large volumes, which works well for the broker.
Disadvantages of no Dealing Desk Broker
Selecting a forex broker is one of the most important decisions a trader can make. The right broker can help you achieve your financial goals, while the wrong one can leads to significant losses. Below are factors to consider when selecting a forex broker.
REGULATION Always open an account with a regulated broker. Brokers are regulated and licensed by the country’s regulatory authority where they’re registered. Regulation ensures that the broker adheres to and enforces strong industry standards and that your funds are safe. In addition, in the case of bankruptcy or insolvency by the forex broker, there will be set procedure that dictate how client funds are to be handled.
List below show countries and their respective broker regulatory agencies
TRADING COST Trading costs are an important consideration when choosing a Forex broker. Due to the high competition, most brokers offer very tight spreads, especially on major pairs. Are the spreads fixed or variable? Are there any additional commissions or fees on opening trades? If you’re a day trader or scalper, trading costs can easily eat up a significant portion of your profits
BROKER TYPE You should know the type of your broker in advance to avoid any surprises down the road. Understand the broker type belong. Market markers with dealing desks, Straight Through Processing Brokers (STP), who markup the price and pass on your order to the interbank market and ECN forex brokers that allow you direct access to the best bid/ask pricing provided by the largest liquidity providers.
CUSTOMER SERVICE In choosing the best online forex broker you should consider those that have 24 hours a day, 5 days a week support. Some brokers actually offer 24 hours a day, 7 days a week support as well. If your trading platforms stops working or you are unable to open, manage or close trades, the first step you need to do is to contact your broker’s support. It can be very frustrating to be on hold for long periods of time or worse not be able to contact your broker directly when you have a question or require immediate attention.
FINANCIAL SECURITY It is important to know how financially strong a forex brokerage institution is for peace of mind of you. Most reputable brokers in highly regulated regions will be required to hold client funds in segregated accounts. The safety of your account should be your primary concern and working with a financially strong capable forex broker will go a long way towards that end.
TRADING PLATFORM What trading tools does the broker offer? Besides free trading platforms (such as Meta Trader), most brokers offer free market analysis, market sentiment indicators and webinars nowadays.
DATA SECURITY When you open an account with a forex broker you will be required to provide some personal and financial information. This could include your bank account, passport, utility bills, and other sensitive data. Choose a forex broker who can assure the safety of your data using a bunch of regulations, tools, and other security measures.
PAYMENT OPTION Before you can start trading, you will need to deposit funds with your forex broker. Do not assume that your broker accepts all different types of funding options. Each broker will have their own policies regarding which payment methods they accept and which ones they do not. It would be wise to check the exact methods of payment available at the broker so as to save you time in case the broker doesn’t accept your preferred funding option. There are certain regulations within some countries which prevent brokers from accepting certain modes of payment for funding a forex account. For example, in the United States, brokers cannot accept credit cards as a funding option.
REPUTATION It is important to choose a broker with a good reputation. Look for online reviews and check the broker’s history to ensure that they have a good track record. A reputable broker should have a long history of successful operation and a large base of satisfied customers.
Spread The spread is the difference between the bid and ask prices of currency pairs. This difference between the bid and ask price is your broker’s profit. While some dealing desk brokers offer fixed spreads, most of the time spreads are variable and depend on the current market conditions.
Leverage The leverage in forex is a way for traders to borrow capital to gain a larger exposure to the FX market. it is a great tool for multiplying your trading volume — it increases both your profits and losses. However, trading bigger lots that become available with 1:100 leverage, a broker earns 100 times more on spreads than it would earn without such a leverage.
Payment processing commission. Online Forex brokers rarely charge commission per trade (except Islamic accounts) and often advertise that as a feature. However, some brokers charge payment processing fees — they are deducted only when you deposit or withdraw money and usually are quite small and fixed in currency units, not percentage points. Of course, such commissions are too small to form a significant part of the broker's profit, but they are enough to compensate at least a part of the broker's expenses.
Commissions/Fees – Besides the spread, some brokers may also charge you a fixed commission or fee per trade. This is especially true with ECN brokers. However, commissions and fees tend to be quite low due to the high competition among Forex brokers. For example, a broker may charge you a $1 commission for a pre-specified lot size, such as 1 lot or 10 lots
Trade against their customer, this happen for market maker brokers is their main source of making money.
Swap Charges, Swap refers to the interest that you pay for a trade that you keep open overnight.