Forex trading
Forex (FX) is a fast-growing industry. The forex market is probably the most liquid financial market and certainly the biggest, with an average daily trading volume of over 6.5 trillion US dollars during 2019.
The forex market is the most accessible of all the online trading markets, offering easy and profitable trading options and requiring low trading capital.
Forex trading allows a trader to buy and sell currencies any time the exchange market is open, providing ample opportunities to generate profits.
However, forex trading is not without its own challenges and risks, for instance, leverage risk, exchange rate risk, and volatility in the market.
Beginners have to be cautious and patient while gaining ground in the forex market.
It is a commonly known fact that a significant number of traders fail in having a go at forex trading. Estimations on websites of how many forex traders suffer losses and eventually quit, differ from 70% to over 90%.
Therefore, if you are interested in forex trading, you need not only a competent and trusted forex broker to guide and help you to become a successful forex trader, but also the right type of broker. Having said that, to identify the right forex broker can be confusing to most novice traders. Hence, an important part of the process of selecting the right broker, is to distinguish between different types of brokers.
Two different types of forex brokers
The choice of a broker is not in the first place about commissions, spreads, and a good reputation, although these aspects are also important. The starting point should be to become acquainted with the different types of forex brokers.
It is important to understand that not all forex brokers are the same. According to which trading model a broker utilizes, there are two different types of forex brokers:
- Dealing desk
- Non-dealing desk
Dealing desk broker
A dealing desk broker, also known as a market maker, is effectively creating a market for clients, providing them with the liquidity to carry out their trades.
Such a broker keeps the orders of traders in-house and does not send them to the real market.
Another characteristic of a dealing desk broker is that he (or she) takes the opposite side of a trader’s trade, implying that the trader trades against the broker. For this reason, markets makers are being viewed by forex traders as having a conflict of interest with them.
Non-dealing desk broker
Non-dealing desk brokers facilitate immediate access to the primary forex market (interbank market), transferring their clients’ trades to liquidity providers, like banks and other financial institutions, for executing.
With a non-dealing desk broker, there should be no conflict of interest between broker and client.
This type of brokers is further split into two categories: ECN brokers and STP brokers.
ECN brokers
ECN (Electronic Communication Network) is the preferred broker trading style among forex traders.
Put simply, ECNs are networks that match buyers and sellers of foreign currencies.
A true ECN broker is one who let you have access to the interbank market (the primary exchange market) and enables you to see the actual prices of other parties that are taking the other side of your trade. Other parties interested in your trade might be banks, financial institutions, and other brokers.
Thus, your orders are allowed to interact with those of other traders with great transparency.
In addition, the best ECN brokers indicate the highest bid price) with the lowest ask price. They offer the best possible spread.
However, the transparency and other benefits come with some costs. ECN brokers have big expenses due to large volumes required and even the best ECN brokers are unable to offer micro-lots to their clients.
ECN brokers earn their money from fees and commissions, which is the main difference between ECN brokers and STP brokers. On ECN accounts, forex traders are charged a fixed commission for opening and closing trades, while spreads depend on the prices of the liquidity providers.
Advantages of ECN brokers
- Great transparency.
- ECN brokers are unable to trade against their clients, thus, no conflict of interest.
- Direct access to the market with the benefit of higher liquidity.
- Better spreads obtaining from different sources.
- No spread mark-up.
- The trades will be completed, and the confirmation will be available immediately.
- Trades remain unidentified on ECN platforms, helping traders to execute transactions that reflect real market conditions.
Cons of ECN brokers
- High fixed commission on every transaction.
- A big deposit is required to open a trading account and to start trading.
- Difficult to calculate stop-loss levels due to variable spreads.
- Trading platform is not user-friendly.
- Probably the biggest disadvantage is that fills are not guaranteed, especially when orders are still pending before important economic announcements.
STP brokers
STP stands for Straight Through Processing.
An STP broker will pass all or some of a client’s trades directly to liquidity providers for execution. By keeping some trades in-house, STP brokers are creating a market for these trades, thus also fulfilling the role of a market maker. Hence, being a “hybrid” between an STP and a market maker.
At times STP brokers differentiate between traders based on their trading behaviour and the size of their trading accounts. A general guideline applies: the bigger the account, the most likely trades of the trader will be executed through the STP server, while smaller accounts will be diverted to the interbank market structure.
There is no conflict of interest if the STP broker is directing all the trades to the liquidity providers. However, unlike ECN brokers, STP brokers can trade against their clients, a situation prone to conflict of interest.
STP brokers are generally considered transparent.
No commission is charged on STP accounts, but STP brokers make money from spreads, for instance, the FX open mark-up is added to the spread of liquidity providers.
Benefits of STP brokers
- Both variable and fixed spreads are available.
- Faster and better filling of clients’ orders.
- Clients have the freedom to avoid quotes.
- Less risk in comparison to other types of brokers.
- Provide live market trends.
Cons of STP brokers
- A price can change within a few seconds.
- Major conflict of interest.
ECN vs STP: Which one?
From the above comparison, it is clear that both categories have benefits and negative sides.
Before you make a choice, it is essential to keep your budget and objective in mind. For example, if you have a restricted budget, it is convenient to choose STP. STP brokers do not charge a high amount to open a trading account.
Comparably, if you have a flexible budget and need a transparent platform, you can think about ECN.
It is more expensive to open a trading account with ECN brokers and they charge commissions for every transaction. Although, there are a number of opportunities to generate profits from forex trading provided by ECN brokers.
Order execution is fast and easy with STP brokers. However, there can be a conflict of interest as they can trade against their clients.
Contrarily, ECN brokers do not trade against their clients and their processes are completely transparent.
Another possibility is to look for a broker who combines both ECN and STP.
