2.4 Types of Brokers in Forex Market
It’s best to know the species!
Brokers may broadly be divided into two categories – ‘Dealing Desk’ and ‘No Dealing Desk’ brokers. The latter group is again split into two kinds – ‘Straight Through Processing (STP)’ and ‘Electronic Communications Network (ECN)’. Dealing Desk brokers are also known as Market Makers.
Initial classification depends on the following criteria:
- Who is actually providing the cash or liquidity?
- Who is deciding the Exchange rate?
- How the Forex broker is earning money.
Let’s say that you are just reached Heathrow airport from New York and before going out of the airport decided to convert some dollars in to euro at the nearest currency exchange counter. You gave 5000 dollars and received 4385.96 euro @ ask rate for EUR/USD = 1.1400.
What did the above transaction mean? You bought euro by selling dollars to the dealer. Or in other words you were on buying side and the dealer was on selling side.
In this transaction the dealer represents the Forex broker and you represent a retail forex trader.
Question 1: From where did the euro come?
Answer 1: The so called Forex broker did. He had a dealing desk.
Question 2: Who decided the exchange rate?
Answer 2: The so called Forex broker did. He made the market rates.
Question 3: In other words who took the opposite position i.e. when we bought EUR/USD who sold EUR/USD?
Answer 3: The Forex broker did.
In practical situation a market maker does not work in this simple way and you will learn more in the following lessons.
Now it is also possible that this guy was just a franchise of the end dealer who decides the exchange rates and provides the cash to him and what this guy gets is a commission on the business or playing with the spreads a bit. In this case he is not deciding the exchange rates.
The above mentioned example is the first important classification for the types of Forex brokers. The basic types are as follows:
- Dealing Desk Brokers or Market Makers
- No Dealing Desk Brokers
The second type of brokers i.e. No Dealing Desk Brokers again have two categories and these are as per the picture at the top i.e.
- STP (Straight Through Processing) brokers
- ECN (Electronic Communication Network) ECN brokers. This type is practically ECN+STP brokers.
Both these types are bridges between the Forex trader and liquidity providers and also bridge builders amongst various trading entities. They do not have a dealing desk and do not act as trader at the other end. They do not decide the exchange rates and hence they are not the market makers.
The workings of all these types may not be as simple as it seems to be here and hence let’s see more details about these types of brokers in the following lessons.
- Types of Brokers