What Is The Function Of A Forex Broker?
When there are two trading parties, a Forex broker acts as a guarantor of creditworthiness and trust between them. Brokers are like middlemen in Forex exchange, similar to real estate agents. Their main function is to sell the product of one client to another one – i.e. match buying and selling orders between different clients. Because of brokers, traders can trade freely and without worry about the settlement of trades. Forex Brokers do not trade against or for their clients – their only job is acting as middlemen between two trading parties.
Another function of a Forex broker is to already have contacts and connections in the industry so that the benefits can be passed on to traders. These benefits largely include preferential rates for trading. The institutions that Forex brokers are affiliated with also get the benefit of bulk orders from traders. Because of their wide network of connections, brokers are able to offer tight spreads to traders. Most brokers have competitive ask and bid prices because of which the trader’s costs come down greatly. Brokers charge a fee for their services and this fee is called “broker commission”.
Order matching is also one of the main functions of Forex brokers. In this, one trader’s requirement (or order) is matched with another trader’s requirement at a quick rate. In the Forex market, even a second’s delay can lead to losses because the market is pretty dynamic. When large funds are involved, as is often the case with Forex, up or down movement by even a single pip can change the game. The speed of matching orders prevents this from happening.
What Are Dealing Desk Brokers?
Dealing desk brokers are a kind of Forex brokers and are also known as “market makers”. They are responsible for creating a market for their clients. This means that they can either take their clients’ side or bet against them. However, this doesn’t give them any conflict of interest. Both a buy quote and a sell quote is offered to the client. Thus, DD brokers fulfill both buy and sell orders. The decisions that a trader makes do not affect DD brokers.
They control the order fulfillment prices. Thus, their risk is little while their spread is fixed at all times. People who use DD brokers will never find out about the true interbank rates. But, because the competition among brokers in the market is so stiff, DD brokers’ rates and interbank rates are pretty close. A trading platform comes between the trader and a DD broker. The client executes a trade on the platform and then it goes to the dealing desk. For the clients who have made winning trades, an offset occurs with other clients. It can also be passed on to another provider of liquidity. In case the client has made a losing trade, DD brokers counter-trade it and convert it into a profitable transaction for themselves.
- When an order is bought (or sold) by the client, the broker’s first attempt is to find a matching order.
- Only when this cannot be done, a liquidity provider (like a bank or similar financial institution) is approached.
- These sizable entities can buy and sell orders of any quantity readily. This minimizes the risk for the DD broker.
What Are ECN Brokers?
ECN or Electronic Communications Network brokers provide direct access to the Forex market for their clients. They deal with a variety of traders and consolidate the price quotations. As compared to other brokers, the bid/ask rates offered by ECN brokers are much tighter. Because their job is only to match trades against each other, there is no conflict of interest. Unlike certain retail Forex brokers, ECN brokers do not trade against their clients. Since their bid/ask rates are much narrower than other, the commission they charge is fixed on a transaction basis. This makes them a bit expensive.
ECNs operate by acting as a bridge between retail traders and financial institutions. Because the ECN technology is pretty sophisticated, this link is possible. The name of this technology is FIX Protocol. For huge currency pairs, the spread with ECN is sometimes pretty close to zero. However, since the money is made on transaction basis, ECNs don’t care about the client’s successes or losses. ECN trading platforms are relatively difficult to master and are ideal for traders who want to deal in a huge amount of funds. Since commission is on transaction basis, high volume of activity and large balances are usually favorable.
The biggest benefit of ECN brokers is that they allow scalpers to flourish. Since there are no issues of re-quotes or order slippage, and the order execution is instant, quick buying and selling is facilitated. However, the leverage offered by them may not be too high. Certain kind of orders (like take profit or stop loss) might also be different as compared to other brokers and platforms.
What Are STP Brokers?
STP brokers are another kind of no dealing desk brokers. There are many brokers who might say that they are ECN brokers but, in reality, they just have an STP system. STP or ‘Straight Through Processing’ system allows these STP brokers to route the client orders to liquidity providers. These providers have interbank market access. STP brokers are usually in contact with a variety of liquidity providers. All these providers quote their individual bid/ask rates, offering the STP broker a wide variety of choice. Their system shows them the liquidity providers (and the offered bid/ask rates) in a list.
The STP broker can sort these rates on the basis of most favorable to least favorable. The best bid rate and the best ask rate would be the real rate for them. However, the trader would obviously not be able to see all the rates from all the liquidity providers. They will only see the best bid and ask rate, with an added markup of a few pips on their screen. Thus, when a trade is placed by the trader, it is routed to the liquidity provider on the best rate. Because the trader is being offered a marked up rate, the difference becomes the broker’s profit.
Since liquidity providers have fluctuating spreads, the best bid/ask rate for traders dealing with STP brokers are also variable. As the spread of the liquidity provider rises or falls, the STP broker has to change their spread as well. However, there are a few STP brokers who offer a fixed spread.