There is a very wide choice of currency broker companies online and when you are starting out in forex trading it can be difficult to find the best. We tend to be attracted by advertising, assuming they are all working in the same way. In fact this is not true. Foreign exchange brokers have very different business models which affect the way that they operate. In some cases, you may be surprised to hear that they could be working against their clients instead of for them.
Of course traditionally a broker carries out his clients' instructions, placing orders for them in the market. Originally brokers worked with telephone orders and simply placed the order for the best price that they could get through their dealing desk. These days, everything is done online so that clients put in their orders for a certain price. However, you do still need a broker who will connect to the market through their software platform.
Many brokers still work in the old way, placing orders for clients as they are instructed. These are often the brokers who run standard forex accounts with minimum investment of $10,000 and upward. But the internet has opened up forex trading to people with much lower investment funds. More recently, companies have come on the scene to cater for these smaller investors and they do not necessarily follow the pattern of traditional brokers. To cut costs, they usually do not have their own dealing desks and they may operate in some very different ways. This can have important consequences for your funds and how they are managed.
So let's take a look at the types of business model that you may come across in your search for a currency broker.
No Dealing Desk (NDD) Currency Brokers
NDD brokers work in a similar way to brokers with dealing desks, but they use a range of liquidity providers to actually match their clients' orders in the market. Competition between liquidity providers keeps the spread low, even though the broker usually increases the spread to cover their own costs and make some money.
Electronic Communications Network (ECN)
Forex brokers who use the ECN can access an online network where trades are filled. Many market makers work this way, as well as some brokers, banks and other large currency traders. Spread is usually low but you may be charged a fee per trade.
Market Makers
Market makers are not brokers in the true sense because instead of placing your order in the market they will match it themselves and then cover themselves against any loss by taking a position in the ECN or market that offsets their commitment to you either partially or fully. Market makers set their own prices, although of course these will be related to market prices. They often do not like clients to use scalping strategies because the very short term nature of these trades makes it hard for them to offset their risk. Some traders are happy to use market makers but others consider that they have a conflict of interest which may work against you as a trader.
Bucket Shops
Forex bucket shops are like bet takers in that they simply match your trade without necessarily taking any position in the market. They may not even have any connection into the real currency market. They win if you lose, so if you are successful they will probably close your account and return your funds. There is really no point in getting involved with a bucket shop unless you just want experience at very low levels of investment, and plan to lose money. They are illegal in some jurisdictions, and do not deserve to be described as a currency broker.
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