If you are looking to become a forex trader, there are many things you need to learn before even considering opening a trading account.
For starters, you will need to learn more about the market and the basic things of becoming a forex trader. This includes learning new terms that traders, brokers, and forex experts use, understanding how currency pairs move, as well as getting familiar with the various types of forex brokers you are going to encounter.
The type of broker you choose is going to influence your trading experience quite significantly, which is why you need to ensure you are making the right decision. There are various types of forex brokers to choose from, each coming with its own perks and flaws, so you need to dedicate time to understand what each type of broker does.
Below are the most common types of forex broker you are going to encounter, so make sure to give it a good read if you want to make an informed decision.
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Dealing Desk
A dealing desk broker (DD broker) is a broker that makes profits through spreads, as well as by providing liquidity to their clients. They are often called Market Makers, so if you ever stumble upon this term, you will know what to expect.
What DD brokers do is they create a market for their clients, providing both a sell and a buy quote. While this may appear as a conflict of interests, it actually isn’t. While the broker does fulfill both sell and buy orders of their clients, they do not influence the actual decision of the trader.
While the trader does not actually see the real interbank market rates, DD brokers usually offer rates that are either very close or identical to these.
To better understand DD brokers, let’s take a look at this example:
If you place an order to buy EUR/USD with your DD broker, the first thing they will do is try to match your buy order to a sell order made by another client. If no client is found, then the trade gets passed on to the broker’s liquidity provider. This is usually an entity that is ready to buy and sell financial assets at any time. Only if this option is not available will the broker have to take the opposite side of your trade.
No Dealing Desk
No dealing desk brokers (NDD brokers) have a different approach to trading. Instead of passing the trader’s order through a dealing desk, they act as a type of mediator between the two parts and allow access into the interbank market. The trading order goes from the broker’s trading platform through the interbank market and then to other clients.
One of the greatest advantages of trading with an NDD broker is the fact that they do not typically re-quote prices. This allows traders to act upon any economic changes or announcements without facing any type of restriction.
NDD brokers usually make profits by either charging commissions or widening the bid/offer spread. There are some NDD brokers that do both, so make sure you read their terms and conditions before opening an account.
While the spreads offered may be lower with NDD brokers, these spreads are not fixed, which means you can take advantage of the market volatility when it works to your advantage.
No dealing desk brokers usually fall into two categories: Electronic Communication Network brokers, and Straight Through Processing brokers. We will be discussing both below.
Electronic Communication Network
An Electronic Communication Network broker (ECN broker) use electronic communication to match sellers and buyers across the market. This leads to great opportunities for traders and allows them to take advantage of favorable market conditions.
People that choose to trade with an ECN Forex broker do so because of a series of advantages this type of broker provides. Among the most most notable ones is the short execution time. When you place a trade, the trade will appear immediately, and with no re-quotes.
Another great advantage of using an ECN broker is the low spreads they provide. Typically, the spread will be among the lowest compared to other types of brokers. However, if the market becomes uncertain, these spreads can also go significantly higher than those of a DD broker.
ECN brokers are often preferred because of the trading conditions they provide, but reliability and safety also play an important role. ECN brokers are perceived as safer and more reliable, as they do not change prices.
Straight Through Processing
A Straight Through Processing broker (STP broker) uses a system to match traders directly with their liquidity providers that have access to the interbank system. These brokers usually have more than one liquidity provider, and each of their providers are allowed to set their own bid and ask prices.
When you place a buy or sell offer, the broker’s system will then list their available quotes from best to worst, so that you can easily sort through your options. Keep in mind, however, that brokers need to make money as well, so they will usually add a fixed markup. This is usually a 1-pip markup.
Lots of people mistake STP brokers with ECN brokers, but as you can see, there is one main difference between the two: while ECN brokers give traders direct access to interact with both liquidity providers and other ECN traders, STP brokers only connects traders with liquidity providers.
Bottom line
Choosing which type of forex broker to open an account with is not an easy task. As you can see, each type of broker provides some great advantages that can be explored as you learn more about the forex market.
To determine which type of broker suits you best, you need to assess your needs very well. Once you have a clear idea of your financial goals and trading style, then you can go ahead and choose the type of broker that suits your needs best.
Disclaimer: This content does not necessarily represent the views of IWB.