Structure of Forex Brokers
June 20, 2019
Structure of Forex brokerage system is among the topics that are taught in forex trading programs. Most Forex retail traders do not think that’s it’s important to understand this. You see retail Forex traders cannot exist without a Forex broker. However, there are very many Forex brokers, offering different benefits, which usually leave many new traders confused.
The challenge of identifying a good broker is common among many new and developing traders, and unless you have a good hint from a friend who has been trading for a long time, you are likely to land in the hands of a ‘hungry broker.’ It is hence vital to understand the different types of brokers we have, and how they operate; this may be significant enough to determine the success of your trading career(we have more rogue brokers than honest ones).
Forex brokers mainly act as mediators between the interbank market and retail market, in return for a commission. Most individual traders cannot afford the cost of trading directly without requiring a Forex broker because it requires a lot of money.
In the simplest form, there two main categories of Forex brokers: Dealing Desk and Non-Desk Brokers. Dealing Desk (DD) are also called Market Makers or Dealers. Dealing desk brokers take trades in the opposite side of their clients as way of managing their risk. In most cases, their spreads are also artificial. It is important to understand that this is just a business model and that traders should not blame their losses on it. The major disadvantage is that such brokers may provide high spreads, hence elevating the cost of trading.
On the other hand, non-dealing desk brokers link their clients trades with the interbank market; such brokers do not make money from spreads, but charge a small commission per trade. Some of them, however, may slightly increase their spreads. Non-dealing desk brokers can be Electronic Communication Broker (ECN), Straight Through Processing (STP) or Hybrid (ECN+STP). ECN brokers offer Direct Market Access, which allows their client’s orders to interact with other participants in the inter-bank liquidity market. The other participants could be small banks hedge-funds, big speculators, other traders, e.t.c.
Direct Market Access (DMA) can be either True DMA or one-touch. Direct DMA places client’s trades in the inter-bank market using different types of automated technologies. On the other hand, one-touch DMA requires human intervention; someone has to check trades before sending them to the inter-bank market-speed of execution could be compromised in one-touch DMA. Small brokerage firms may prefer one-touch to make sure they have enough funds to take execution. Brokers in some countries are also obliged to use one-touch due to the set regulations that prevent True DMA due to reduce risks of Fraud. STP are a hybrid of both market maker and ECN in the sense that they may either place your trades in the inter-bank market, or on their dealing desk. Most of them make their money by adding a margin on spread. Large STP brokers offer good services to their customers due to economies of scale.
Now that you already know about brokers, it’s also important to understand that there are many dishonest brokers who take advantage of unsuspecting clients; you may trade profitably with a trader but when it comes to withdrawing your money, the rules change and you are left frustrated. Dishonest brokers, mostly market makers, will close your trades almost at will during volatile sessions, even when price has not hit your stop loss, and will try to justify it with a lot of jargon to keep you off. Such brokers also charge disproportionate swaps to pay for short term changes of interest rates by central banks. I hope that this information has been useful and will help you choose a forex broker.