Before choosing the best forex brokers, you must know all the types of forex brokers out there. Why do you need to know that? Because each type of forex broker is suitable for different levels of traders. You need to choose the right type in order to succeed in this market.
There are two main types of forex brokers in the market:
Dealing Desk brokers are also called Market Makers. No Dealing Desk brokers are divided into two types: Straight Through Processing (STP) and Electronic Communication Network + Straight Through Processing (ECN+STP). Read more for the details of each type.
Dealing Desk brokers are those who make money from spreads and the service of providing traders with liquidity. We can call them Market Makers.
Dealing Desk brokers create markets for their clients, meaning they often trade against their clients. Do you think it is a conflict of interest? It's not really like that. Dealing Desk brokers provide liquidity for both buying and selling sides, which means that they buy and sell your trades at the same time.
For example: You place an order to buy 1 lot (100,000) EUR/USD with Dealing Desk broker. To match your trading volume, that Dealing Desk broker will find suitable sales volume from other customers or they will switch to other liquidity providers.
This way they will minimize risks, as they make money from spreads, without having to confront clients. However, if they can’t find the same liquidity as your transaction, they will have to confront your trade.
Different forex brokers will have different risk management policies, so make sure you check the policies before deciding to open a forex account.
No Dealing Desk brokers don’t create markets like Dealing Desk brokers. This type of forex brokers earn money by charging commission or raising the spreads a little bit. No Dealing Desk brokers can be STP or STP + ECN.
The STP forex broker will direct clients' transactions straight to liquidity providers and interbank markets. This type of forex brokers usually has multiple liquidity providers, each of whom would offer different bid/ask prices (spread).
For example: your STP broker has 3 liquidity providers, each of whom will offer different bid and ask prices. The broker’s exchange system will arrange the prices and request the best price. In this case, the best bid price is 1.3000 (you want to sell high price) and the best ask price is 1.3001 (you want to buy low price). The bid/ask price is now 1.3000/1.3001.
Will this quote appear on your trading platform?
No! Your forex broker is not a charity. To compensate for their risks and operational costs, your forex broker will vary slightly. The quotes you’ll see on the trading platform will be 1.2999/1.3002.
When you decide to buy 100,000 EUR/USD at 1.3002, your transaction is sent through your broker to either liquidity provider A or B. If your transaction is accepted, liquidity provider A or B will sell 100,000 EUR/USD at 1.3001 and you have an order to buy 100,000 units of EUR/USD at 1.3002. Your forex broker has earned 1 pip of revenue.
The bid/ask quotes often change which is why most STP brokers offer flat spreads.
A true forex ECN broker will allow their clients' trading orders to interact with other trading orders participating in the ECN system. ECN participants can be banks, retail investors, hedge funds and even forex brokers. Basically, participants exchange with each other by providing their best bid/ask price.
ECN also allows its customers to see "Depth of Market". Depth of Market displays the buy and sell orders of participants. Due to the nature of ECN, it is difficult to increase spreads to gain income, so ECN forex brokers often earn income through a commission. They charge commission for their service.
Obviously, there is no better type of forex broker. Each type is just suitable for different type of traders, so let’s see which type of forex brokers is suitable for you:
Just like I have said in many other articles, there are many forex trading strategies used in the market. Just like traders, each strategy is the most effective when you use it with the suitable type of forex brokers.
Dealing Desk brokers obviously have wider spreads than No Dealing Desk, so traders who need tight spreads should trade with STP or ECN brokers. On the other hand, Dealing Desk brokers hardly charge commission or charge less than No Dealing Desk. So, if your strategy is long term, consider trading with Dealing Desk brokers.