Forex trading guide – Step 1: your broker

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When it comes to trading in the forex (foreign exchange) market, it’s important you start off right.

Before you decide to transfer your hard earned money to the next best broker that offers you “x USD bonus for x amount of deposit” you should know that there are a lot of sketchy brokers out there that are eagerly awaiting your first deposit.



A lot of brokers offer you a bonus on top of your first deposit because they know you will not survive for long. This is partial because a vast majority of traders lose in the long run but it’s also because they aren’t always honest in there ways.

Broker types

Dealing Desk (DD) and None-Dealing Desk (NDD)

There are two types of brokers. Both have their own way of providing you with a way to trade in the currency market. It’s paramount that you know the difference before you start trading.

The two types of brokers are:

  1. Dealing Desk brokers aka Market Makers
  2. Non-dealing Desk brokers

Dealing desk broker

To get a clear understanding of what a dealing desk broker or Market Maker is, consider the following quote for the EUR/USD pair.

Ask EURUSD Bid
1.1409 1.1407

If you wish to place a buy order, it would be at the price what the buyer is asking for his position, aka the ask price, in this case, 1.1409. When you place your order of a certain volume at a certain price, there has to be the opposition willing to take it.

Here comes the dealing desk broker into play. If there is no matching order from the other clients and no trades with its liquidity provider, the broker takes an opposite position.

Dealing Desk brokers have a dealing desk through which all trades are sent. In doing this they “make the market” for their traders. In other words, a DD broker is also called a Market Maker.

The broker is always ready to act as a counterparty to the clients’ orders. Whether a client wants to either buy or sell. A dealing desk makes money by charging a fixed spread and sometimes, in case the he has to make a counter-trade, on the position he had the place for the client.

The later statement might make it seem like a DD broker stands more to gain from you losing, it’s not really the case.

How do dealing desk brokers make money?

The dealing desk provides both the selling and buying prices, i.e. ask and bid rates with a fixed spread. The broker can afford having fixed spreads even during more volatile moments. The reason for this is they are the ones providing the quotes, any changes in the rates, will also be quoted by them. After all, they are making the market.

Mitigating the counter-trade risk

So, the broker tries to fill the client’s order by matching it with another party. What if he can’t find one and has to open a counter-trade? If he can’t find another party, he will match the client’s order and open a counter-trade.

It’s easy to think that the broker would want his clients to lose in the aforementioned case. It’s not that simple. If the client loses and keeps losing, he will lose a client. the broker might “lose” if the client wins, but if the broker wins, he might lose the client.

In order to minimize this counterparty risk, he has various techniques available. These techniques will vary from broker to broker due to their business policies, the regulations put on them by the Securities and Markets Authority (SMA), etc.

Non-dealing desk broker

These brokers do not have a Dealing Desk between the trader and the market. They do not offer their own quotes and hence do not make the market. Traders’ orders are matched directly to another trading entity in the market. These trading entities may be an interbank market, hedge funds, other Forex brokers, Mutual funds or even other clients. They will match your order for the quantity and price with any other counter order available to them. In simple terms what they do is bridging of demand and supply.

Order execution and confirmations are very fast and there are no re-quotes on orders. This is particularly useful during important news releases when the market makes sudden and volatile moves.

These brokers, the NDD kind, make money through:

  • Commissions
  • Offer an increased bid-ask spread and not charge commissions
  • Charge a commission as well as a higher spread than the market makers

The No Dealing Desk type brokers are never a counterparty for any trade position you take. They are just matchmakers and are unaffected by any profits or losses you make.

Straight-Through Processing (STP) non-dealing desk Brokers

While STP brokers don’t have a dealing desk, they do have an interface between the trading client and their liquidity providers, the whole market. These are banks which trade on the interbank market, and to where the clients’ orders get passed to.

As an example we have the following rates from the various liquidity provers:

EUR/USD Bid Ask
Liquidity Provider X 1.1502 1.1505
Liquidity Provider Y 1.1501 1.1504
Liquidity Provider Z 1.1499 1.1501

The STP broker will retrieve the best bid and ask price it receives from his providers to show to his client.

From the example, the best exchange rates are:

  • Bid price (sell high): 1.1502
  • Ask price (buy low): 1.1501

Before you get the actual rates, a markup is added. This markup is where the broker gets (part of) his revenue. The size of the markup will depend on the policy but it will be very tight during calm periods and widen during volatile news events.

The final client rates are thus:

  • Bid price (sell high): 1.1503
  • Ask price (buy low): 1.1500

The original one pip spread became three for you the client.

During breaking news, i.e., the Brexit referendum, US elections, Non-Farm Payroll data, etc. prices change constantly. While your broker does his best to fulfill your request immediately, they can move against him at any time. To protect against such events, spread widens. Another reason is that both the bid and ask rate can come from different providers at any given moment so the spread between the best rate can vary.

Electronic Communication Network (ECN) plus STP non-dealing desk Brokers

ECN is an acronym for Electronic Communication Network. As the name entails, these are electronic networks that a trading entity can use to connect and trade other market participants.

These market participants are retail traders, interbank market & liquidity providers as well as other ECN brokers. An ECN broker ensures your privacy and does not identify you. Only needed data to submit your bid or ask quotes and volumes are shown.

clients using an ECN broker thus participate directly with the main market and its participants.

Depth Of Market for EURUSD

Depth Of Market for EURUSD

Because the broker does not participate he can show the actual trading positions and corresponding quotes. This a key element of an ECN broker. It allows the client to see the Depth Of the Market (DOM).

This DOM is the key characteristic of an ECN broker.

Just like with STP, the different market players are connected in a transparent way. Because of this, an ECN broker is an ECN+STP.

Due to the nature of ECN, it’s very difficult to add a fixed markup, though not impossible, most of the time compensation happens through a commission.

Which one to choose?

To summarize, there are two major types of brokers: Dealing desk and Non-dealing desk. With a non-dealing desk broker, you have two “sub-types”, namely one that does Straight-through Processing or STP and one that does ECN in addition to STP.

Below is a clear table:

Dealing desk Non-dealing desk STP Non-dealing desk STP + ECN
Fixed spread Variable spread Variable spread + commission fee
Can be the counterparty No counterparty risk No counterparty risk
Provides the quotes Quotes come from liquidity provider Quotes come from liquidity provider and other ECN parties displays Depth Of Market (DOM)
Broker fills the client’s order Auto fills and no requotes Auto fills and no requotes

With this information, choosing the correct broker should be a bit easier. However, saying that “the best” broker is a non-dealing desk STP + ECN broker, is too short-sighted. Now, if it isn’t that simple, then which one do you choose?

Like with most things in life: “it depends”. You can discern three main things when evaluating a broker:

  1. Security
  2. Costs
  3. Convenience

For each of these three categories, you will have two distinctions: Must-haves and Nice-to-haves.

The following must-have example questions can help you find the best broker for you. You will have to find a balance between security, costs, and convenience. The perfect broker doesn’t exist.

Security

The most important thing when selecting a broker is security. It’s important you spend a lot of time on this topic. You won’t just hand over your money to the first broker that claims they are legit, right?

  • Are they registered with at least one regulatory body?
  • What are the options to withdraw and deposit your money?
  • Is there client portal secure (identifiable by the green lock next to the URL)?
  • How is your money stored at your broker: a separate account or one big pot?
  • What will happen in case of bankruptcy?

Note: It’s not because the broker registered itself with reputable regulatory agencies (NFA, FCA, ASIC, EMA, etc.) that it protects you against fraudulent practices. It can also mean that malpractices are better hidden and harder to find. They will also not refund your money in case you are the victim of a scam.

Costs

Regardless of the broker, you choose (transaction) costs are a part of forex. With the following questions, you should be able to find the most cost linked to trading.

  • Do they charge a fixed or variable spread?
  • How much is the spread, if any?
  • Do they charge commissions; how much?
  • Are there charges for withdrawing or depositing money?

Note: Besides the broker, especially when you wish to withdraw funds, additional charges may apply. This is certainly the case when your account currency differs from your bank account currency and if the headquarters of the broker is off-shore. You might have to sacrifice cheaper transaction costs for a better trading experience.

Convenience

  • Is it easy to reach their support in case of problems?
  • How hard is it to deposit and withdraw money?
  • How hard is it to navigate on their site/platform?
  • Are all the necessities easily found?
  • Which trading platforms are available for trading. Can you try out the platforms through a demo account first?
  • Which additional options do they offer for your needs (VPS service, MAM, PAMM)?

Note: Most if not all brokers (even the more obscure ones) offer at least the MT4 or the updated MT5 platform. It’s fairly easy to obtain an MT4 license. If they make it very easy and clear to deposit money but the withdraw process is obscured away, they might not want you to ever withdraw.

Using the above questions, you can now find your preferred broker. If you are still undecided or need an example of good brokers you can get help from the forex review site, ForexPeaceArmy. This site has literally thousands of reviews of hundreds of brokers. In some cases, there are court rulings and other proof of fraudulent practices.

Looking or our top 5 most reliable brokers? Click the button to get an overview of our preferred brokers.