You decided to enter the gates of forex trading. After doing some research, you moved on to determining your forex broker.
When deciding a forex broker, you were overwhelmed with different types of forex brokers.
Now you are thinking, which type of forex broker is best for me?
That's why we are here!
In this guide, we'll tell you different types of forex brokers and their roles. We'll also tell you how you can select a forex broker based on its functionality.
What is a forex broker anyway?
For those of you who don't know, first, let's explain what a forex broker is.
Let's assume you're looking for an apple and decide to go to a street market. You want to purchase an apple, and the street market is the best place to do it because people sell apples.
Assume you're now selling apples and need to locate consumers; you may go to the street market because that's where your clients are — individuals who are looking to purchase apples.
A street market is a gathering area for shoppers and vendors. When you go to a street market, though, you won't find many individuals selling apples to one another; instead, they'll sell through a stall.
This is no different in the currency markets. You have buyers and sellers of various currencies who need a place to meet and a way to purchase and trade those currencies.
The buyers and sellers in the forex, on the other hand, are thousands of kilometers away. Therefore, they must meet through a marketplace to discover each other. This is when forex brokers enter the picture.
Forex brokers serve as a link between you and the interbank market. A network of banks that trade with each other is an interbank network if you are unfamiliar with the term.
Each broker has a different vibe and has its own set of advantages and disadvantages. For example, some brokers emphasize customer service or low costs, while others provide more sophisticated tools and resources. Knowing your investment approach and the areas in which you want your broker to excel can help you limit down your options.
Types of forex brokers
Now that you understand what a forex broker is, let's move towards the main part of this guide.
There are three types of forex brokers; dealing desk, STP, and ECN. We'll go over each one in detail.
1. Dealing desk or Market makers
The phrase "dealing desk" comes from the days of traditional offline trading, when financial organizations maintained a desk where traders would sit and oversee the institution's investments. Brokers with a dealing desk work in a closed environment, setting their pricing rates and filling their customers' orders.
They do this either by meeting their clients' buy and sell orders or accepting the order's counterparty if you can't fill it. A Market Maker is a broker who owns a trading desk.
The role of market makers
For every deal, a counterparty is sourced from a pool of orders from traders or by the broker taking the counter-party themselves.
Market Makers can establish their pricing since they do not take their trades to the interbank market. Consequently, people often believe that market makers bet against their clients' success, when in fact, they quote both a buy and a sell price that move in lockstep.
If the broker raises the price of EUR/USD, it will spend any money from filling sell orders on buy orders and vice versa. As a result, spreads account for the majority of these Forex brokers' profits.
Because dealing desk brokers have complete control over the prices at which orders complete, there is a very slim possibility that they will set fixed spreads.
While clients may not have access to actual interbank market rates, but they give extremely close prices, if not identical to interbank rates, due to the fierce rivalry among brokers.
How to spot a market maker?
Keep in mind that every scam broker is also a Market Maker, but not all Market Makers are scams.
It's much the same as before. This is one reason to proceed with caution when choosing a dealing desk (DD) broker. The key distinctions you'll notice are that a legitimate Market Maker will frequently issue requests. Moreover, they have regulations from reputable bodies.
Pros of dealing desk/market makers
● Your trades are completed instantly at the rate you choose.
● Fixed spreads - when you join a transaction, you know what spread you'll pay.
● A large number of leverages - some brokers provide leverages of up to 1 x 500 for individuals with a good risk appetite.
● There are no rollover costs, since counter-orders offset most orders; thus, no money changes hands and no extra swap fees are there.
Cons
● Prices from the interbank market may change (slightly in most situations).
● When the broker can't find counterparties for your transaction and isn't prepared to take it on themselves, liquidity may be poor.
● If the broker's dealing desk mishandles, the broker may go bankrupt.
2. STP
STP brokerage firms do not have a dealing desk. Still, they use some of the same strategies as Market Maker brokers to give more flexible trading circumstances to their clients and avoid some of the drawbacks of trading only in the interbank market.
Prices for these types of brokers are often similar to interbank market rates. STP brokers, like ECN brokers, execute trades directly in the interbank market as a priority.
When the interbank cannot identify a counterparty for a request, the STP broker can either serve as a Market Maker and match the order within its customer base or become its counterparty.
The role of STP broker
STP brokers use sophisticated algorithms to determine whether routing your transactions to the interbank market is more profitable for them than trading directly against you. As a result, some traders may route large deals that are lucrative to the interbank market while covering minor losing trades themselves.
In this approach, the broker may profit from the tiny lost transactions while avoiding the risk of taking larger trades to the market.
How to spot an STP broker?
Unlike market makers, STP brokers have changeable spreads. In addition, compared to all other types of forex brokers, STP brokers have fewer accounts. So, if you go to a broker's website and notice that the broker has two accounts, you're dealing with an STP broker.
Pros of STP broker
● The prices are the same as the interbank rates.
● Re-quotes or trade rejections are uncommon, especially during periods of high volatility.
● There is a wide variety of leverages available, up to 1 x 500.
● Entry capital needs are lower.
● Trade sizes are smaller.
Cons
● Dynamic spreads-when you enter a trade, you have no idea what the spread will be.
● Rollover fees.
3. ECN
Electronic Communications Networks brokers provide clients with access to other market players in the equities and currency markets. As a result of combining quotations from numerous market players, an ECN broker can give clients a narrower bid/ask spread than would otherwise be available.
The function of an ECN broker
The only function of the broker in the transaction is to connect buyers and vendors. They don't establish their prices or control inventory in any manner because all of their prices source from the interbank market.
ECN brokers earn money by charging spreads between bank rates or by charging fixed transaction execution charges. However, because interbank spreads are dynamic, ECN firms cannot easily offer fixed spreads because they would lose their commission.
While this may appear to be the simplest approach for a Forex trader (and it may be for some), it does necessitate a considerably larger initial investment capital because most participants in the interbank market only trade substantial quantities. As a result, ECN brokers may impose account minimums ranging from $1,000 to $50,000.
Furthermore, because there is no guarantee that a party in the interbank will accept your transaction at the given price, ECN brokers may be unable to conduct your trade at that fee and must requote or decline your order.
How to spot an ECN broker?
Because they promote themselves as such, ECN brokers are the simplest to discover.
Pros of an ECN broker
● The interbank market provides direct price rates.
● Tight margins.
● The broker does not compete with you in any way.
● The broker cannot go bankrupt by trading against its customers.
Cons
● Dynamic spreads-when you enter a trade, you have no idea what the spread will be.
● Leverage is limited.
● Commissions on rollover fees.
4. Hybrid
Because traders need a plethora of facilities, brokers have devised a hybrid broker type. These brokers can provide STP and ECN accounts while also being able to become DD brokers.
The role of hybrid broker
Although your forex broker is your counterparty always, using a hybrid approach involves your broker deciding whether to execute your trades within the company or offset them to a liquidity provider elsewhere.
Combining the ECN or DMA with STP methods to produce an electronic forex trading service is an example of a particularly frequent hybrid. This popular combination enables a forex broker's order input, dealing spread pricing, and trade execution components of their deal execution company to automate entirely.
Furthermore, following system construction, employing this type of ECN or DMA and STP hybrid model generally allows a forex broker to cut expenses.
How to spot a hybrid broker?
Most brokers nowadays are hybrid brokers. You can easily sport them from their fair pricing structure. But, at the same time, they show the qualities of dealing desk brokers and will trade against you.
Pros of hybrid brokers
● Variable and fixed spreads are available.
● The minimum deposit is usually modest.
● Orders executes both instantly and on the market.
Cons
● Trade against your trades
● Slow execution of orders.
So, which type of forex broker is the best?
When it comes to the question of whether one brokerage type is better than another, there isn't a simple answer. This is because each broker type caters to a particular set of traders.
Forex firms that offer market execution with no requotes are an excellent choice. However, professional traders advise against dealing with brokers who use virtual dealers.
Are there any scam brokers?
Yes, there are plenty of them. For example, a scam broker is a firm created purely to defraud new and inexperienced traders who could fall for it and deposit money with them.
You'll get a plethora of results if you type in "scam broker" into any search engine of your choice.
When looking at such a broker, certain telltale indications should raise red flags:
If some unknown individual on the internet contacts you and offers to double, treble, or quadruple your money in a week, month, or so, that should be a major red signal.
There is no regulation or licensing number on the site. Alternatively, it may state that the brokerage is "self-regulated."
There are many forex market scams out there, so how can you select the best forex broker?
Here are some of the things you need to do before selecting any broker:
Look for regulations
This is an important part. As we know it now, the forex market is a relatively young business with a wide range of rules that vary depending on the broker's location. Certain countries have stringent regulations that the government strictly enforces.
Brokers regulated in the US, UK, Canada, or Australia are subject to tougher restrictions than most other nations.
First, the legislation safeguards banks that engage in currency trading. As banks trade around the globe, they take on national and credit risks, and there are procedures to safeguard them as much as possible.
Before selecting, be sure to read our broker evaluations to discover whether a broker has the tools, resources, and reputation for meeting your needs.
Before you jump, have a look around
Make sure you understand what you're doing before putting your money on the line—trading is usually less risky and more rewarding when you know what you're doing. Don't worry if you're a complete beginner; almost every respectable broker offers extensive training and courses on how to trade currencies efficiently and without prior expertise.
Great client service
It may be a lonely climb to the top when it comes to online investment. You don't have many people surrounding you or advising you. But, when it comes down to FAQs or any queries, you may profit much from a broker's customer service, and many provide excellent assistance and instruction to both novice and experienced traders.
However, some companies provide superior customer service than others. If you are a newbie or believe, you would benefit from having staff on hand to advise you or answer queries, do some preliminary research beforehand.
Affordability
You want to get the most bang for your buck with any service, so it's only reasonable to evaluate how much a broker costs for each deal. If your broker charges fees in addition to spreads, combine the two to see whether the final price is acceptable.
Don't be alarmed by overnight rollovers; they're a regular cost, and the difference in exchange interest rates can occasionally work to your advantage. However, keep an eye out for hidden costs like "account inactivity" penalties or excessive withdrawal fees.
Multiple tradeable products
Even though forex is your main game, it's always a good idea to diversify your portfolio by having alternatives to grow into other assets.
Stocks, commodities, metals, energy, and cryptocurrencies are now available from nearly every broker.
Besides, a broker should have major forex pairs. While there are many forex pairs accessible for trading, like minors and exotics, a few attract the most eyeballs, and, as a result, you have to trade with the most liquidity.
The major forex trading pairs include EUR/USD, GBP/USD, USD/JPY, and USD/CHF. It does not matter how many forex pairs a broker offers; what matters is that they offer the pairs that interest you as a trader.
Trading platform
The trading platform is the investor's gateway to the markets. Therefore, make sure that the broker's platform and software support the tools you need, and that both can be used quickly to begin and exit trades.
Demo account
Practice makes perfect, and nothing beats a demo mode for putting new abilities and techniques to the test.
Make sure you have infinite virtual money and actual market rates in your demo; else, your practice will be useless in the real world of financial markets.
Final thoughts
To express the obvious, it is dire that you understand the type of broker with whom you will be dealing. Simply because you need to trade with a reputable broker who matches your trading style to start making money from forex, and you don't want to be concerned about the safety of your cash.
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