Forex brokers and their issues

Tuesday, March 1, 2011

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Before delving into the many issues of forex brokers today it would be best we define what a broker is before really jumping in. In simple terms a broker could be referred to as a go between, a middleman and or an agent. Now in the case of the forex market they are regarded as the agent responsible for linking the buyer and the seller to the market place. Since many big and successful forex brokers have big banks that provide them (the brokers) market prices, these market prices are transferred to traders as the bid/ask price.

To fully understand these brokers, one would really have to consider knowing the different types of brokers available. There are just four types of brokers but other school of thought may think differently. These are:

1) Market Makers/DD

2) NDD

3) STP

4) ECN

These are the four available types of brokers today (though I personally like to think there are just three).

1) Market Makers/DD: These brokers are to say the least not looking for your best interest as they have "dealing desks" (DD). Forex brokers that operate (route orders) through the Dealing Desk and quote fixed spreads. A dealing desk broker makes money via spreads and by trading against its clients. A Dealing Desk Forex broker is called a Market Maker - they literally "make the market" for traders: when traders want to sell, they buy from them, when traders want to buy, they sell to them, e.g. they will always take the opposite side of the trade and in this way "create the market". A trader doesn't see the real market quotes, which allows Dealing Desk brokers (Market Makers) manipulate with their quotes where they need to in order to fill the client. They make money from the bid/ask price which more often than not is manipulated. In my books this makes the market makers a "no no" for any trader who wants to succeed. Painfully most of your "micro accounts" are owned by these market makers. This is so because they may not have liquidity providers and since micro accounts do not require large sums of money they are willing to give traders a hard time. So if a trader must have a winning spree, such trader would want to avoid trading the news hours since the "market maker" brokers will be able to manipulate the prices as they so wish.

2) NDD: Meaning No Dealing Desk. These type Forex brokers provide access to the interbank market without passing orders trough the dealing desk. With true No Dealing Desk brokers there are no re-quotes on orders and no additional pausing during order confirmation. This, in particular, allows trading during news times with no restrictions on trading. An NDD broker can either charge commission for trading or choose to increase the spread and make Forex trading commission free. No Dealing Desk brokers are either STP or ECN+STP.

3) STP: Simply means, "Straight Through Processing". These types of forex brokers send orders directly from clients to the liquidity providers - banks, which trade on the Intebank. Sometimes STP brokers have just one liquidity provider, other times several of them. The fact remains that the more there are banks and liquidity in the system, the better the fills for the clients of such brokers. Since traders or clinets of such brokers have access to the true market and can execute trades immediately without dealer intervention, this makes brokers operating the STP platform very transparent in their dealings with clients and is perceived by traders to be honest to a large degree.

4) ECN: Meaning "Electronic Communications Network". They are the most transparent of all other types of brokers and so are usually regarded as the purest form of what a forex broker should be, because of their services and qualities. ECN Forex brokers additionally allow clients' orders to interact with other clients' orders. ECN Forex broker provides a marketplace where all its participants (banks, market makers and individual traders) trade against each other by sending competing bids and offers into the system. Participants interact inside the system and get the best offers for their trades available at that time. All trading orders are matched between counter parties in real time. A small trading fee - commission - is always applied. More often than not sometimes STP brokers are discussed as if they were ECN brokers. Well the truth is to be a true ECN, a broker must display the Depth of the Market (DOM) in a data window, let clients show their own order size in the system and allow other clients to hit those orders. With ECN broker traders can see where the liquidity is and execute trades. ECN Forex brokers always have variable spreads. Only ECN brokers charge commission for trading Forex. Commission is the only revenue/profit an ECN broker receives. ECN brokers are not making money on bid/ask as do the market makers.

CONSIDERATION SO FAR

For the sake of clarity we shall have a quick preview at all types of brokers earlier mentioned above to ascertain which should be best for doing business with. We have discussed the Market makers and see them as what many traders refer to today as "bucket shops" since they legally trade against their clients. They have a dealing desk which means all orders pass through that desk so they decide whether or not the price is good for you. In plain words they do not seek your success as they make money coming against your open positions in the opposite direction; so that when your trade goes bad they simply would have made money from your losses, as well as from the bid/ask price which they manipulate at will.

Then we moved on to the NDD brokers and referred to them as transparent. This is because they allow for instant execution of trades without re-quotes. They do not operate dealing desks and do not trade against clients. We also stated that they could come in STP or ECN+STP.

Getting warmer now we entered the terrain of the STP brokers.Praising them for not having a dealing desk and having liquidity providers (banks).We mentioned that the more availability of such providers and their liquidity (money), the better for their clients because they would get good fills on prices.

Finally the we plunged into the ECN brokers, calling them the purest form of what a forex broker should be. They do not trade against their clients but rather, they allow for a fair market situation thereby making money only from commissions and not from their clients open positions.

A good thinker would have concluded by now which type of broker would best suite thier portfolio. I believe the obvious choice would be within the ranges of the last three types of brokers, but preferably the last one, the ECN brokers. Having said that, it is not as easy as it may appear to be, due to the fact that most ECN,STP and NDD brokers require larger sums of money to run an account. In some cases, you would find brokers requiring up to ten thousand US dollars ($10,000) to open an ECN account. In less milder cases half of that amount is required, which is five thousand US dollars ($5,000). Better situations would require far less as low as two thousand to even one thousand US dollars ($2,000 - $1,000).

This situation, leaves the financially less privileged traders, at the mercy of the "bucket shops" or market makers, who off course require far lower than the above mentioned, from as low as fifty to three hundred US dollars ($50 - $300) to open and run an account. New traders fall into the trap of these market makers, since they perceive them as lenient to their status. Traders would only begin to find out their brokers' lapses only after a few days or weeks, which may be too late by then, as they would have lost a great part of their capital or the entire amount.

SOLUTIONS AND CONCLUSION

Before depositing your hard-earned money to any broker, one would do well to do proper searches on search engines, to enquire about such brokers. Reading forex brokers' reviews would be eye opening for any newbie. There are a number of accredited brokers out there, as well as dirty ones, that are even unregulated. You would need to do your searches to sieve out the good from the bad ones. If you still have issues with making sound decisions with which broker to go with, you could jolly well reach us on our blog @ www.fxtrendman.blogpot.com where you could throw in your comments and questions, even after the posting period of this thesis has expired and we would be glad to give a helping hand. Be sure to leave your e-mail address so we can send you the information you need.


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