What Are the Advantages of and Fees for Trading With a Forex Broker?
FOREX brokers provide two basic services to traders: (1) they cause trade orders to be executed; and (2) they provide margin -- loans used for funding partially-collateralized trades -- in ratios up to 500:1. In addition, they may offer niceties, such as real-time charting platforms or a view of all pending orders. There are several types of FOREX brokers who provide different advantages and fee structures. Some are fine for all traders, including beginners, and are certified by a national regulator like the U.S. National Futures Association. Others border on the dishonest and should be completely avoided.
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Dealing Vs. Non-Dealing Desks
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In an ideal marketplace, a trader would like to transact with the all market participants directly, as this fosters the most competition and the truest prices. A Non-Dealing Desk, or NDD, broker is a conduit from your order entry system to a FOREX marketplace. A Dealing Desk, or DD, broker batches orders together and tries to net buy and sell orders internally before forwarding the orders to the interbank markets. NDD brokers operate in real-time, so traders are less likely to experience "slippage" -- price movement between the time you place an order and the order executes. NDD's offer superior transparency and anonymity as compared to DD brokers.
Straight Through Processing Broker
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An STP broker is a type of NDD that connects traders in real-time to the FOREX interbank market. One of the banks in the interbank market then executes the trade on the broker's behalf. An STP broker charges customers by marking up the bid-ask spread: trades in which the prices bid have been raised and the asking prices have been lowered. The difference between the actual interbank bid/ask spread and a STP broker's marked-up spread constitutes the broker's source of revenue. A typical STP broker markup is one-half to one pip -- one pip is equal to 1/100 of one percent.
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Electronic Communications Network Broker
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An ECN broker is another type of NDD. All active FOREX traders are represented in the ECN market, including banks, market makers, and individuals. ECN brokers provide the fastest feeds to the largest audience. Unlike STP brokers, ECN brokers provide a window to the current depth of market (DOM) -- the current open bid and ask prices and volumes for each FOREX currency pair. A trader can directly select a counter-party using the DOM window. An ECN broker charges a trade commission for each transaction instead of marking up bid/ask spreads. Small traders may find ECN fees higher than those of STP brokers; large traders may receive rebates from ECN brokers to encourage order flow.
Market Maker
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A market maker operates a dealing desk and quotes marked-up bid/ask spreads to traders. They profit by spread markups and by acting as the counterparty -- the opposite side of the trade -- to a customer's order. The advantages of using market makers are that they often allow smaller accounts and provide higher margin ratios. However, because traders never see the real interbank bid/ask prices, they can be vulnerable to a market maker that manipulates prices for its own benefit. Most market makers are honest and don't manipulate prices, but a trader should perform research to distinguish the good ones from the bad.
Bucket Shops
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These are dishonest market makers who trick traders into substantial or total losses over time. They are illegal in the U.S. and are not certified anywhere. Bucket shops often don't actually trade positions -- they instead offer sky-high margin ratios, hold traders' money and simply wait for "trades" to fail. Basically it is a Ponzi scheme; they count on the quantity of losing trades to overwhelm the number of winners. Avoid bucket shops at all costs -- insist on certified brokers with substantial track records.
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