An Introduction to Forex: Part 2
In the first part of our Introduction to Forex we talked about basic concepts and characteristics of Forex trading. In this part the focus is on the different types of Forex brokers. This should give you a clearer picture of how the Forex machine works, and how to select the right broker.
There are three main types of Forex brokers out there, namely Market Maker brokers, Electronic Communications Network (ECN) brokers and Straight Through Processing (STP) brokers. Each type operates and makes money in a different way, and it is important to know the difference before deciding which one to use.
Market Maker Brokers
Market Maker brokers are the most common. They are named Market Makers because they essentially “make” the market for their customers – they buy when a trader wants to sell and they sell when a trader wants to buy. Using a Market Maker broker, you will never see the real market quotes, because all your trades will be routed via the broker’s dealing desk. These brokers make money in two different ways. The first way is by quoting fixed spreads (the difference between buy and sell price). The second way is by hedging against their clients’ trades. This means the broker makes money every time you make a loss. Ridiculous, right?
The only real benefits of using a Market Maker broker are the low amount of funds required in order to open an account, and user-friendly trading platforms. The low amount required is mostly due to the high leverage offered, so you should put that into consideration before deciding to invest.
Electronic Communications Network Brokers
ECN brokers provide direct market access. That means you get access to the market where all of the players (i.e. banks, financial institutions, and individual traders) trade against each other in real-time. The price displayed by the broker is the actual inter-bank rate, and the spread is variable – sometimes the buy price can even equal the sell price. All of the placed orders are matched between the participating parties in real-time, and there is no dealing desk routing. Simply put, you gain access to the true Forex market. These brokers don’t make money by setting a spread, but rather by charging a commission on every trade executed. The height of the commission depends on the broker and on the amount traded.
The benefits of using an ECN broker are quite obvious. First of all, there can be nospread/price manipulation by the broker, since the price is quoted directly from the inter-bank market. Next, the spread is variable and that can be used to the trader’s advantage. Last but not least, your broker is not trading against you, like the evil Market Makers do. The only two flipsides worth mentioning are the high amount of funds needed in order to open an account, and a not-so-user-friendly platform.
Straight Through Processing Brokers
STP brokers are a sort of a hybrid between Market Makers and ECNs(but not really). They don’t route the orders via a dealing desk, meaning they send them directly to the liquidity providers – banks, for example.Traders gain access to real-time market quotes, and can execute trades without the intervention of dealers.The brokers make money not by charging commissions, but by adding markups to the spread.
The main benefit of using STP brokers lies in the bypass of dealer desks, which means the broker won’t profit when you make a loss – how decent of them. That being said, STPs still don’t grant the trader direct inter-bank access, which puts them at a disadvantage when compared to ECNs.
Which One Is Best?
So which one to choose? If you have enough money you are willing to invest, and don’t mind the increased complexity of their trading platforms, ECN brokers are definitely the way to go. They are superior to STP and Market Makers in almost every way, making them the right choice for anyone who wants to get serious about trading.