Brokerage Types

 

Brokerage type of a broker can be definded as the business model that the broker choose to follow. Brokerage type of your broker decides the way your trade to be executed, even affects on your trading result. Therefore, you need to clarify it before choosing any broker.

 

There are two main brokerage types: Dealing Desk and No Dealing Desk. Then, No Dealing Desk brokers continue to divide into three sub-types: Regular STP brokers, DMA/STP brokers and ECN/STP brokers. Let's learn about them all.

forex broker types

 

Dealing Desk Broker (Market Maker Broker)

 

Dealing Desk brokers are also known under another name: Market Maker. Their name describes their characteristic: they make the market. In a market maker system, orders of clients routed to a "dealing desk" (like an order processing center), at which orders will be classified and processed. Dealing desk makes its own quoted price to offer clients within its system. Although this quoted price is not the real interbank quoted price, it's very close to because of the stiff competition between dealing desk brokers. The question is "Do dealing desk brokers trade against their clients?". To answer this, we have to dig more into how a trade is executed in dealing desk model.

 

Trade process in dealing desk model

 

In trading process, orders are sent from clients through trading platform on their computers to the dealing desk. In order to guarantee that all of these orders will be executed, broker may has to cover (or hedge) positions by taking the opposite side of the trades. That mean they may buy when a client sell and they may sell when a client buy, this rule is applied for every clients' positions.

 

These positions will be put into a "pool" at which each position of clients will be matched up with an opposite position inside the system. Which positions can not find an opposite partner within the group of clients then will face two of broker's choices: Hedge it with an opposite position of liquidity providers on the interbank market or keep it for the broker their own. Of course, broker will definitely hedge the clients' winning positions and keep the clients' losing positions (which means broker's winning positions). Following illustration shows the trading process of dealing desk (or market maker) model:

dealing desk broker model

Dealing desk broker model

 

Some say that dealing desk brokers always trade against their clients since there is a conflict of interest. But it isn't really like that. They only take the opposite trade when a losing position is redundant within the system. Due to nature of their business model, they have a motive to do this. So, the truth is dealing desk brokers have the possibility to trade against the losing clients only, not all clients as some said. However, some bad dealing desk brokers have third choice for client's winning position: Deny to execute. When client's position take advantage right at the entry point and the dealing desk cannot hedging it with interbank since the price change rapidly, then bad dealing brokers will deny to execute that order while the good one will still take the opposite losing position as an acceptable risk (they never lose actually because of spread they received). This action is usually hiden by a reason that the execute price is not available, also know as "Requote" message in trading platform. Note this point to distinguish the good dealing desk brokers and the bad ones.

 

How a dealing desk broker benefits?

 

Like any other business, dealing desk brokers have to make money. They are compensated from the spread between the bid price and ask price they offer to clients, which means they always buy low and sell high. Their another income is profits from clients' losses. Here are the benefits a market maker get in each case of a client's trade:

Client's trade Market Maker's Action Benefit
Win

Pass it to interbank market

(Own spread) - (Interbank spread)
Match it up with another client's losing trade Own Spread
Lose Match it up with another client's winning trade Own Spread
Take the opposite position Client's loss + Own Spread

This shows that the desling desk brokers always get benefit regardless clients win or lose, but they will get most benefit with losing clients. For this manner, it's seem that dealing desk brokers would please to see losing clients since it may turn into their profit. This may become a cause for fraudulent manipulations, but it doesn't neccessarily mean that all dealing desk brokers are fraudulent.

 

In additional, most brokers have their regulatory body as a supervisor that they have to strictly follow unless they want to close their business. In general, a smart broker would choose to making profits from spread in long-term instead of trying to cheat their clients in short-term.

 

One more thing, remember that you won't lose money if you enter a right trade, this truth can not be changed and broker can only take money from the losers. So, the most important thing is don't be a loser by trading the right way.

 

No Dealing Desk Broker

 

No Dealing Desk brokers allow clients to access to interbank market without routing orders through a dealing desk. They don't take any position in the market. Their job is merely openning a portal for clients to join the bigger playground: interbank market, which traditionally welcomed "big boys" only, such as banks, financial institutions, hedge funds and very high net-worth speculators.

 

The highlights of no dealing desk model are transparency, lower spread and faster orders filling. Formerly, traders have to own a very high capital in order to enjoy the advantage of this model. But nowadays, more and more no dealing desk brokers have lowered their condition to attract clients.

 

In order to make this model work, no dealing desk brokers use STP protocol (Strait Through Processing), which pass all clients' order to liquidity providers without any human's intervention. All positions will be automatically executed at the Bid/Ask price that liquidity provider give.

 

In general, all no dealing desk brokers are called STP brokers. However, they are divided into 3 sub-types: Regular STP, DMA/STP (Direct Market Access STP) and ECN/STP (Electronic Communication Network STP).

 

Regular STP Broker

 

Regular STP brokers fill all orders of clients then hedge them with the liquidity providers instantly. But unlike dealing desk brokers, regular STP brokers don't fill clients' orders manually, they do it all by an automatic system. STP brokers don't trade against their clients. Regular STP brokers earn by marking up the spread from liquidity providers a little before give it to clients then mark it down before give it back to liquidity providers. Some STP brokers charge a fixed commisson instead of marking up the spread.

 

By this model, regular STP broker might offer fixed spread and instant execution. It's possible that if the system of regular STP broker cannot hedge clients' position with their liquidity providers (especially in fast moving market like news release), clients might suffer the "re-quotes" which means the order is rejected.

 

DMA/STP Broker (Direct Market Access)

 

DMA stands for Direct Market Access. As their name, DMA/STP brokers send orders directly from clients to liquidity providers that they have contract with (some brokers have one liquidity provider while others have several). DMA/STP brokers act as a bridge connecting traders to liquidity providers. Due to nature of this model, clients' orders are filled directly with liquidity providers without any "re-quotes". Avoiding "re-quotes", but clients might have to face "slippage", which means the order will be filled at current price at the moment it is liquidated, that not the price on screen at the moment you place the order. To learn more about this, you can read at "Market execution vs Instant execution".

 

DMA/STP brokers get raw Bid/Ask prices from their liquidity providers (mostly are banks), then they combine the highest bid price and lowest ask price to make the "best price", which probably have lowest spread. Like in regular STP system, this spread is marked up a little before posted on the trading platform for clients to trade. Markup amount maybe 1 pip, 0.5 pip or 2 pips depend on broker policy. Occasionally, if the highest bid is higher than lowest ask, then DMA/STP brokers will offer clients the zero spread. Let's assume that there are 2 brokers having different raw Bid/Ask prices from different liquidity providers, see how they re-provide Bid/Ask price to their clients:

Broker

Liquitidy

Provider

Bid/Ask

Highest Bid/

Lowest Ask

(Broket get)

Markup

Spread

Quoted price

client get

Broker's

Benefit

STP 1 A 1.20010/1.20020 1.20010/1.20015 ±0.5 pip (each side)

1.20005/1.20020

(Spread = 1.5)

1 pip
B 1.20000/1.20015
STP 2 A 1.20010/1.20020 1.20015/1.20005 ±0.5 pip (each side)

1.20010/1.20010

(Zero spread)

1 pip
C 1.20000/1.20005
D 1.20015/1.20020

The spread you see on the trading platform is surely wider than the tight spread that DMA/STP brokers received from providers. It's obivious that which broker has much more and/or better liquidity providers will offer better spread to his clients. DMA/STP brokers offer variable spread, since they have to combine the best Bid/Ask prices from different liquidity providers. However, instead of marking up the spread, some STP brokers choose to apply a commisson on all trade and give the raw spread to clients.

 

Orders from clients will go directly to the best suited liquidity provider (buying orders go to lowest ask price provider, selling orders go to highest bid price provider), but through a "gate" at which DMA/STP brokers mark down the spread back or charge commisson as their compensation.

STP broker model

STP (Regular STP and DMA/STP) broker model

 

Since there is no conflict of interest between brokers and their client in STP model, they would probably not intervene into their clients' trade. However, the fact is some STP brokers still run their bussiness in a hybrid model: STP + Market Maker. Those STP brokers have to sign contracts with liquidity providers that determine the minimum transaction volume will be accepted by each liquidity provider (which usually must be higher than 0.01 standard lot or 1,000 units). Therefore, all orders which are below this minimum level will be covered by those STP brokers as in dealing desk model since those orders can't interact with liquidity providers.

 

ECN/STP Broker (Electronic Communication Network)

 

ECN/STP brokers (also called as ECN brokers for short name) is pretty similar to STP brokers but they are more open as they create a marketplace that allows all participants includes banks, hedge funds, market makers and individual traders interact with each other directly. All participants send their competitive Bid/Ask price on a the system through an ECN trading platform to find the best matched oppsite parties in real time. The Bid/Ask price showed on trading platform is the best Bid/Ask price at that moment. A true ECN broker probably provides the Depth of Market (DOM) in a data window of trading platform, which shows the volume of opening and pending orders at different price levels within the system. This feature allows traders to watch the trade flow and where their positions is on the marketplace.

 

ECN brokers don't serve for free, of course. In order to benefit from this modern technology, clients have to pay commission. This commisson is usually charged in a round turn lot basis - include enter and exit position (e.g., $10 for trading 1 round turn standard lot). Unlike two STP brokerage types above, ECN brokers don't earn the spread, they are compensated by commission only. With a simple math, you can find out that total commission plus very tight ECN spread usually lower than marker makers' spread or STP's markup spread you have to pay.

ECN broker model

ECN broker model

 

Although ECN is not real interbank market, it works very similarly and be considered as "small interbank market" in which each participant acts as a bank. The extreme low spread between bid price and ask price (sometime at zero) makes ECN model become the ideal environment for scalping technic, in which trader can earn a lot of profits by open and close positions within a very short period of time to take advantage of every price's fluctuation.

 

Compare brokerage types

forex brokerage types

Each brokerage type has its own pros and cons as well as be suitable with different needs of clients. Let's list out the most features of those brokerage types to compare them:

Dealing Desk Broker No Dealing Desk Broker
Market Maker Regular STP DMA/STP ECN/STP
Trade against losing positions of clients Possible to trade against small size and losing positions of clients Not trade against clients Not trade against clients
May have conflicts with client's benefits May have conflicts with client's benefits No conflict with client's benefits No conflict with client's benefits
Require lower minimum deposit

Require lower minimum deposit

Require lower minimum deposit

Require higher minimum deposit
Price is quoted by broker Price is quoted by market Price is quoted by market Price is quoted by market
Clients pay market maker spread Clients pay markup spread or commission Clients pay markup spread or commission

Clients pay commission

Instant or Market execution Instant or Market execution Market execution Market execution
Possible slower execution Faster execution Faster execution Faster execution
Possible requote Possible requote

No requote

(always executed)

No requote

(always executed)

No slippage with instant execution No slippage with instant execution Possible slippage in fast moving market Possible slippage in fast moving market
Fixed or Variable spread Fixed or Variable spread Variable spread Variable spread
Easy-use platform Multi-choice platforms Multi-choice platforms Professional-use platform
Not show the liquidity Not show the liquidity Possible show the liquidity in Depth Of Market (DOM) Show the liquidity in Depth Of Market (DOM)

Possible 4/2 quoted digits

(less accurate price)

5/3 quoted digits

(more accurate price)

5/3 quoted digits

(more accurate price)

5/3 quoted digits

(more accurate price)

Note: Green: Pros; Yellow: Neutral; Red: Cons

 

From this table, there are many factors that need to be considered before chosing an appropriate broker. We can not give you any speacific recommendation because it all depends on your needs.

 

If you are newbie in forex and you just want to try a little of money at the initial or what you need are easy-use platform, faster execution speed, fixed spread to easier calculation, risk guaranteed from slipage in unusual market condition, then you may choose a dealing desk with instant execution. If you are at a higher level that put importance in fair-play, lower trading fees, professional trading style or take the advantage of DOM, then STP or ECN maybe your choice.

 

Recently, there are many brokers have multi-role in brokerage. They can be either market maker or STP or ECN, depend on the account type they provide. This flexible business model helps those brokers to attract more type of clients as well as keep clients if they want to change the brokerage model.

 

After knowing about all breeds of broker, you need to know more about how to trust in them. Let's read the next part.