Brokers

Types of Brokers


Jul.20.2013

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There are two main types of brokers:

>Dealing desk (DD)

> No dealing desk (NDD)

No dealing desk brokers can be further subdivided into straight-through processing (STP) and electronic communication network + straight-through processing (ECN+STP).

There is an ongoing debate among traders as to which type of broker is better. While NDD brokers advertise that being a no dealing desk broker is fairer to the customers, many traders believe that whether a broker is a dealing desk or not is unimportant.

 

Dealing Desk Brokers

Also called market makers, dealing desk brokers literally create a market and forex exchange rates for their clients. Market makers provide both a sell and a buy quote, which implies that they are indifferent to the trader’s decision.

Clients of dealing desk brokers do not see the real interbank market rates. Since market makers control prices, they are also able to set fixed spreads, which can be a great advantage for your trades.

This shows how a DD broker works.

Danial Fig20 01

 

After you place a trading order on your platform, your broker will first try to find an order that is the same size as yours, but in the opposite direction. If you place a buy order, it will be offset by a sell order, and vice versa. Your broker will pass on your trade to its liquidity provider if it can’t find a matching order.

By doing this, the broker minimizes risk, as it earns the spread without having to take the opposite side of your trade. However, in the event that there are no matching orders, it will have to take the opposite side of your trade, and since it is a dealing desk, this process is often done by a person and not an algorithm. Different brokers have different risk management policies, so it is important to check with your broker regarding this. Highly regulated firms are held to stringent standards, and price manipulation is strictly illegal in all the jurisdictions in which they operate.

No Dealing Desk Brokers

A no dealing desk broker often passes your trade straight to its liquidity providers, but at times, and in the event that it fails to hedge your trade, it will have to take the opposite side of your trade just as a dealing desk broker would. Well, almost. A no dealing desk broker usually does this through an algorithm and not an actual human trader in its office.

Danial Fig20 02

No dealing desk brokers can be either STP or STP+ECN. Some brokers claim that they are true ECN brokers, but in reality, they merely have a straight-through processing system.

Forex brokers that have an STP system route their clients’ orders directly to their liquidity providers, who have access to the interbank market. NDD STP brokers usually have many liquidity providers, with each provider quoting its own bid and ask prices. The broker’s system sorts these bid and ask quotes from best to worst, selects the best price, and shows something similar on your platform. I said “something similar” because your broker adds a small markup to the original price. This is another way of making money for NDD brokers.

True ECN brokers, on the other hand, allow their clients’ orders to interact with the orders of other participants in the ECN.

Participants could be banks, retail traders, hedge funds, or even other brokers. In essence, participants trade against one another by offering their best bid and ask prices.

ECNs also allow their clients to see the "depth of market." Depth of market displays where the buy and sell orders of other market participants are. Because of the nature of an ECN, it is very difficult to slap on a fixed markup, so ECN brokers usually get compensated through a small commission.

So to sum up the whole NDD-DD story, as FXTimes analyst and trader Fan Yang puts it: “All brokers have to hedge . . . but that's not defined as trading against the trader. They just have to take the opposite side of your trade sometimes. So with a dealing desk, there are people making those hedging decisions, but without a dealing desk, they have some algorithm that still does the same.”

It is important to remember that being a NDD doesn’t mean that a broker isn’t a market maker. A NDD broker still uses an algorithm to not only match your trades, but also make the market, just as a DD broker does.

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