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UNDERSTAND FOREX BROKER
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.
TYPES OF FOREX BROKER
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
- No Dealing Desk Broker
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 --- Straight Through Processing
- ECN—Electronic Communication Network
- ECN + STP (Hybrid 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
During unstable trading environment some NDD broker higher valuable spread. This can result in delays in execution, or in some cases, the inability to execute trades at all.
Commission will be charged for every order trader take especially for ECN broker
With a no dealing desk model, spreads are typically variable, which means that traders may not know exactly how much they will pay in transaction costs. This can make it difficult to accurately calculate potential profits and losses.
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