The forex market is ultimately made up of everyone and anyone who participates in the exchange of one currency for another. Whether it’s the tourist that exchanges a few hundred dollars for vacation spending, a large multi-national corporation conducting a multi-billion-dollar international transaction, or anyone in between including traders entering and exiting long and short positions, all participants in foreign exchange transactions make up the forex market that trades in excess of $5 Trillion in volume per trading day. Forex brokers are the financial institutions that facilitate forex transactions and trading by bringing together, via technology, buyers and sellers of the various currencies in an efficient and competitive virtual auction environment in which the prices of currency pairs can be driven solely by supply and demand. The Forex Brokers are compensated for this service by charging fees, or by taking the spreads of the transactions.
Types of Forex Brokers
Forex Brokers are generally categorized as dealing desk (DD), or non-dealing (NDD) desk types of brokers. A dealing desk type of broker (also referred to a market-maker) is one that takes the other side of the trade. For example, when a customer trader places an order to buy a currency pair, the market maker will become the seller and fill the order at the current market price, regardless of market conditions. At this point, the market maker either maintains the short position in an attempt to make a profit from it, or immediately goes into the market and liquidates it to avoid a loss. There are advantages and disadvantages to using a dealing desk. First, spreads are usually fixed (advantage). However, they’re typically larger than non-dealing desks (disadvantage). Second, liquidity is readily available to the trader, and therefore quicker execution should be expected (advantage), This is what the trader / customer is paying for with wider spreads. Another advantage is the traders are customers, and they are transacting directly with “their” dealer. The protocols of competition and “good customer service” thus apply; especially if you have a sizable account.
The two main trading types
There are two types of non-dealing desk brokers. The Electronic-Communications-Network broker (ECN), and the Straight-Through-Processing broker (STP). Both are similar in that they are a system that bypasses the dealing desk, and directly matches buyers with sellers in the market. Just like the dealing desk, there are advantages and disadvantages. Transaction costs vary depending on market conditions. Spreads are usually tighter, however, they may widen significantly in fast moving markets. ECN brokers, while they do have tighter spreads, typically charge a small commission fee for each trade. Non-dealing desk brokers display quotes that come directly from the market, and provide market depth information, while dealing desk only display their own bid and ask quote. This allows traders to see the status of their pending orders on a montage screen and gives them some insight to the status and depth of the market.
Choosing a currency trader
What type of broker is better is dictated by the style of trading that a trader engages in. For short term intraday traders or scalpers that are looking to make small quick profits on smaller scale trades, the size of the spread is important. In this case, the non-dealing desk brokers may be better suited. For traders that take a longer-term approach on larger scale positions and seek much larger profits on each trade in which spread are considered negligible, a dealing desk broker may be better suited. Most Forex Brokerages offer a variety of options to traders. Traders should carefully examine each option and select the one that give their trading strategy the highest probability of succeeding. This should be combined with a thorough review of their trading platforms to ensure that you have a system that you can utilise and understand.