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Traditional Brokers

Is Your Forex Broker Working For You?

People new to foreign exchange trading may be surprised to find that their forex broker may operate in some surprising ways. In fact, some companies offering forex trading services are not brokers in the traditional sense at all.

Traditionally a broker would work for you as a client, placing your buy and sell orders for you through their dealing desk and charging commission (for stock exchange transactions) or making their money from the spread (the difference between bid and ask prices) for forex trading. At one time orders would be placed by telephone. Now they are placed online, with you in full control of your account.

But standard forex accounts require significant investment. Typically the minimum deposit is anything from $10,000 to $50,000. Now that forex trading can be done from home, there are many new services springing up with lower deposit requirements, offering forex mini accounts. But their business model is not necessarily the same as traditional brokers, and this can have implications for you.

So these days, there are other types of companies that operate in different ways in order to provide services to the smaller investor. Most of these do not have dealing desks of their own.

Forex NDD (No Dealing Desk)

Brokers without a dealing desk communicate with external liquidity providers to provide prices and match clients’ trades. Because there is a range of liquidity providers, the real spread tends to be small but the broker may increase the spread to give themselves a reasonable profit margin.

Forex ECN (Electronic Communications Network)

ECN brokers provide a marketplace where many market users including banks, market makers and regular traders can see to have their trades filled. Trades will be entered in the name of your ECN provider for anonymity. Spread is generally small but the ECN will often charge a matching fee per trade.

Forex Market Makers

When you have an account with a market maker, your trades are not being matched by external providers but by the market maker themselves. This means that they take the opposite position and offer their prices to you, although of course these prices relate to the current price in the market. They will then offset their risk by taking an equivalent position to yours in an ECN or other environment.

Since they are not actually placing your order in the market, market makers are not brokers in the true sense of the word although most traders use the term forex broker loosely and include them. Others consider that the difference between market makers and bucket shops is not clear and prefer to avoid them.

Forex Bucket Shops

Bucket shops work a little like market makers but they do not offset their risk and may have very little connection to the real spot forex market. When you deal with a bucket shop you could be said to be betting against them. They oppose your trade and they profit by your loss. Like commercial bet takers, if you are successful they tend not to want your business and will probably close your account, returning your funds to you.

Bucket shops are illegal in some jurisdictions, and even if they are legal in your country, they are best avoided, certainly for beginners. A bucket shop is working against you, not for you, and is not a forex broker at all.

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Saturday, November 27th, 2010 Brokers, Strategy No Comments