Different Types Of Brokers

You may not want to know it, but there are different types of Forex Brokers. Chief among these are Dealing Desk brokers (DD) and No Dealing Desk brokers (NDD). Of course, you are probably wondering how you can deal if they do not have a dealing desk, but stick around and we’ll explain.

Dealing Desk brokers are also known as Market Makers. Meanwhile, No Dealing Desk brokers can be further divided into STP (Straight Through Processing) and ECN+STP – Electronic Communication Network + Straight Through Processing. Don’t worry: all will become clear.

Dealing Desk brokers make their money through spreads, and also providing liquidity to their clients. They are also known as Market Makers, since they quite literally create a market for their clients, often taking the other side of the client’s trade. They offer both a buy and sell quote, so they fill both the buy and sell orders of the client.

Market Makers control the prices at which they will fill the orders, so they can also set fixed spreads with very little risk to themselves. This is a benefit to you as a trader, which we’ll explain later.

As a client of a DD broker, you won’t be shown the actual interbank market rates, but this is not a problem, since the competition between individual brokers is fierce, and you will find that the rates offered are very close to – if not the same as – the interbank rates.

Let’s take a look at an example. Suppose you want to buy a standard lot of 100,000 units of GBP/USD. Your broker will first try to find one of its’ other clients who has a sell order of the same size. If they cannot do that, they will pass your order on to their liquidity provider. This way, they minimize their risk since they earn from the spread without having to make the other side of your trade themselves.

However, if they cannot find any matching orders, they have to take the other side of your trade. Each broker will have different policies regarding risk management – which they obviously want to minimize as far as they are concerned – so you need to check exactly what these are.

So what is a No Dealing Desk broker? Basically, what they are doing is connecting two entities, you and a trader who is offering the opposite side of the trade that you wish to place. They earn money by gaining a mark-up by increasing the spread a little, or by charging a small commission. NDD brokers can be either STP or STP+ECN brokers.

What’s the difference?

A Straight Through Processing broker will direct your order straight to their liquidity provider who will be able to access the interbank market. Most NDD STP brokers have a large number of liquidity providers, each of which will have its own bid/ask rate.

As an example, let’s say that the bid and ask prices of different liquidity providers are as follows.

First liquidity provider has a bid price of 1.4540 and ask of 1.4543

Next liquidity provider shows a bid price of 1.4541 and ask of 1.4543

Third liquidity provider has a bid price of 1.4542 and ask of 1.4544

Your broker’s system will then sort these out into the best and worst bid and ask quotes. In this example, the best bid quote is 1.5642, because you want to sell at the highest price, and the best ask price is1.5643, because you want to buy for as little as possible.

Once your broker’s system has sorted this out, your bid/ask is now 1.4542/1.4543.

Is this the price that you will see on your platform?

No, don’t be silly. Your broker wants a cut on this deal as well, so what usually happens is that he will add a small mark-up. Let’s say this is 1 pip. What you will be quoted is 1.5641/1.5644. Although the best spread is only 1 pip, it becomes a 3 pip spread for you.

When you say that you want to buy a standard lot of 100,000 units of GBP/USD at 1.5644, your order goes to either the first or second liquidity provider each of which has a short position of 1.5643, while you have a long position of 1.5644. So your broker has earned 1 pip on the deal.

Because the bid/ask quotes are variable, this is also the reason why your broker probably has variable spreads. When the spreads of their liquidity providers widen, they have to widen theirs as well. Certainly, there are some brokers who do offer fixed spreads, but most of them do not.

So then, what is an ECN broker? An ECN broker (Electronic Communication Network broker) lets the client’s order interact with the other participants in the ECN. These could be various banks, hedge funds, other retail traders, or even other brokers. To put it at its’ simplest, all participants are trading against each other, quoting their best bid/ask prices. Furthermore, ECN’s also let you see the “Depth of Market”. This lets you see the buy and sell orders of the other participants. It also makes it difficult for ECN brokers to charge a fixed mark-up, so most of them will charge a small commission on the transaction.