Every time that you buy a stock the price of that stock would be the same no matter which broker you bought it from. This happens because the stock market field is strongly regulated and the prices are obtained from one central exchange such as the New York Stock Exchange. There are many different types of brokers including stockbrokers, forex brokers, and many others. In the Forex market, it works a little bit different because the prices are not obtained from one central exchange instead they are derived from the Interbank market.
The Interbank market is a conglomerate of various banks and financial institutions that provide prices for currencies to various different Brokers around the world. The prices provided by these Brokers will vary depending on the relationship between themselves and the Brokers, so obviously the better the relationship, the better or the cheap the prices are.
What is a Forex Broker?
To kick things off, let’s first talk about what is a Forex broker? A Forex broker is simply a vehicle that gives individuals like us access to the markets. It’s an intermediary or a middleman between you the trader and the foreign exchange market that facilitates your trades, both the buys and the sells orders. Usually, they are licensed and regulated by national regulatory bodies.
A Forex broker will charge their clients a commission or fees or a spread - fixed and variable spreads. Depending on the type of your broker they can charge you a combination of commission and spread. This should be considered to be just the cost of doing business in facilitating your traders. It’s important to note that different brokers have different levels of engagement with their customers.
Different Types of Forex Brokers
In the Forex industry, there are two different types of Forex brokers:
Dealing Desk (DD) brokers or Market Makers (MM);
No Dealing Desk Brokers (No-DD) which can be further divided into three separate categories:
ECN (Electronic Communication Networks)
ECN + STP (Straight Through Processing)
DMA (Direct Market Access)
The ECN and STP broker is transacting your trades directly into the market or with their liquidity providers. On the other hand, some brokers are going to make their money by taking the opposite side of your trades – dealing desk brokers. These types of brokers are trading against their clients. So, when that happens basically there’s a conflict of interest because when you win they lose and when you lose they win.
Guess who is going to lose more often? The house always wins.
A dealing desk broker will be holding your trades on something called the B book. This means that they sort of manage their trades internally usually through a dealing desk. Generally, when a broker is using a B booking approach then they’ll do all sorts of internal controls to manage their risk, to hedge positions and to make sure their volumes are balanced and things like that. They do this also to reduce the risk of them to lose money.
When a trader starts becoming consistently profitable or starts trading really large volume this presents a bit of a problem for a dealing desk broker. And in this situation, they run a different book called the A book where they place the profitable traders so they can either hedge the whole A book or simply sends the order coming from the A book directly to the Interbank market.
In a DMA environment, multiple banks will feed quoted prices to the DMA broker. The DMA broker will aggregate these quotes and select the best available bid and ask price, which means you’ll have the best available spread. In other words, the client will be sending his orders directly to the Interbank market and you’ll be having complete transparency on who is on the other side of your trade.
How to Choose a Forex Broker
There are so many Forex brokers out there that it has become a difficult task to know how to choose the “right” broker. The most important point you need to look out for is regulation. If you want protection and assurance then you need to check first of all that your broker is regulated.
Your broker can be regulated by a shady jurisdiction, which we recommend to avoid, or they can be regulated by big financial institutions which have bigger resources and strict financial requirements like the UK FCA (Financial Conduct Authority) or the USA NFA (National Futures Association) and CFTC (Commodity Futures Trading Commission). These regulatory bodies are more trustworthy and their umbrella of regulation has also more integrity.
Understanding the business model of your Forex broker is the next thing you should look for when choosing a Forex broker. This is really important, especially if you’re going to be trading large amounts of money. In general, you want to choose brokers that are not going to trade against your position. In other words, you must avoid dealing desk brokers and chose a non-dealing desk broker.
A non-dealing desk broker has a vested interest in you doing well because the more you’re trading the more money they’re making from commissions. So, they are on your side in this situation.
Another criteria for a good Forex broker is the one broker regulated by a jurisdiction that offers some kind of deposit insurance. So, in the case your Forex broker goes out of business you at least can get your money back.
Last but not least, you should look for a reliable speed execution. Trading in fast-moving markets such as the Forex market means that you want to be able to enter and exit the market quickly. Any delays can either cause you to miss a good trading opportunity or even worse, it can make your losing position even bigger if you can’t exit your trades instantly.
With so many options available to choose from we hope that this Forex broker guide can help you better examine your broker. Ultimately, besides the security of your funds and the integrity of the Forex broker – regulation – you want to choose a broker that covers all your personal needs as a Forex trader.
The bottom line is that if you trust your broker, you’ll be in a position to focus your time on the things that matter most which are developing your trading edge and your Forex strategy. But before sending your money to any Forex broker, doing some research will help you gaining access to a fairly trading environment that can ultimately increase your odds of success.
By Suren Subramaniam | 3 November 2020