The foreign exchange market is not a centralized market. This means that buyers and sellers do not meet at one point on the stock exchange – currency trading takes place in parallel on many markets that can be accessed by a Forex broker. The course from the platform is only a reflection of the rate created by the largest institutions that exchange currency with each other. The main entities responsible for a country’s currency are Central Banks, which are responsible for liquidity and currency exchange. The price is only a benchmark for other investors involved in currency trading, i.e. smaller entities. Where is our place in this chain? It all depends on the order execution model that our broker has.
Models of order execution
1. Broker Market Maker (MM)
The first type is called Market Maker. This name is infamous in the forex environment, but how does it really work? First of all, it is the most popular model. In a nutshell, the broker creates a market for us, so at the same time it is the other party to the transaction that the previously dealing desk has to accept. Our loss means the broker’s profit. Often traders are afraid of choosing a marketmaker, fearing unfair practices. Of course, there are a large number of institutions that prey on naive clients. In fact, it is enough that the MarketMaker broker is based on statistics and does not have to interfere in the transaction concluded by investors. Why? – simple, because they will lose most of them anyway. Market Maker has its obvious advantages. First of all, it allows you to open very small items (so-called microlots / nanolots). Market Maker also often offers a fixed spread – very beneficial for beginners. For such people, another feature of market makers will be equally important: negative balance protection – you will not lose more than you deposit (Applies to the countries of the European Union).
2. Broker ECN
The second model of order execution is ECN – Electronic Communication Network and it is a model that, to a great extent, allows brokers’ clients to participate in the real currency exchange market. ECN is only an intermediary between us and the liquidity provider (other players, banks, institutions). Our transactions are anonymous for the broker.
However, ECN brokers also have some disadvantages – the limitation of this model is functioning within one system. The system of a given broker which can generate re-quotes and exchange rate differences in relation to other models. The spread is generally lower than in the case of MarketMakers, in the period of lower liquidity – e.g. on New Year’s Eve, but also during the night in Europe, just before the Asian session, where liquidity is at the minimum level, and in these cases the spread may increase several times. It should be noted that this model, unlike MarketMaker, does not protect against a negative balance.
3. Broker STP
There is an intermediate model between ECN and MM – STP, which is gaining more and more popularity among informed investors. The assumption is that this broker is also only supposed to broker trade and transmit our orders to liquidity providers, with the difference that it does not do it, unlike ECN within a closed network. The clients of the STP broker also do not participate in the creation of the market order book.
The big problem is that the STP name is not a legally protected trademark, so it is often abused by brokers as a marketing ploy. The absence of a conflict of interest sounds tempting to customers, but often it has nothing to do with reality.
4. Broker MTF
Another model appears in Poland: the MTF. It is often compared to an exchange because it has a similar structure, the difference is that the MTF does not offer a central clearing model. MTF, like ECN, allows us to participate in the real forex market, but it does it in a different way.
MTF liquidity providers only send ‘Limit’ orders to the order book. Put simply, this means that when the client’s order reaches the broker, it will be executed immediately (at the price visible on the platform. In the case of ECN, the order must additionally be executed with liquidity providers who have the option to modify the price – which can be seen through re-quotes and price slips. The MTF model also does not protect against a negative balance.
DD and NDD brokers – what’s the difference?
On the Internet you can also find a division of brokers into DD (with Dealing Desk) and NDD (without Dealing Desk). What’s the difference?
A broker with Dealing Desk is a model in which the broker acts as a market maker, i.e. directs all orders to the so-called Dealing Desk where the quotation is made to a fixed spread. This type of broker makes money both from your profit and when you lose. The broker creates the “other” side of the order, while the trader does not really see the real prices that currently exist on the market, and this allows for any price manipulation. Similarly, the NDD broker does not animate the market and all orders are executed without its interference.
Which Forex broker to choose?
When choosing a broker, we should first of all start with defining clearly defined needs. He will help us with a few questions:
-what is my forex experience
-if I know the rules of currency markets / CFDs and do I accept the risk of a loss higher than my capital
-what deposit can I spend on investments
on what time interval I make transactions
-what instruments do I trade
-can I speak English (account opening process / complaints / support)
-in what currency do I keep my account and in which I settle accounts with the tax office, are they not a problem with currency conversion
After answering the above questions, you should only look for Forex brokers who meet all the conditions that are priority for you. Remember that when choosing a Forex broker you should not compromise – these usually always end in unpleasant surprises.