How Forex Brokers Work

[ellliottt]

Like any other business in the history of business, your broker’s raison d’etre, is to make as big a profit as possible. There are about as many ways to go about this as there are brokers. For those who are in it for the long haul, however, it is generally best to adopt a set of practices which are deemed fair by their clients: certain boundaries are set, and operating beyond them can cost a brokerage its reputation, and along with it its clients. Straying outside these boundaries, therefore, is not considered as being in line with the long term goals of the business. How strictly these boundaries are enforced, especially when there is little chance of clients ever even becoming aware of any transgression, again varies from business to business. For the sake of simplicity, in this article we assume that everyone in the business is squeaky clean, as if every client could peek into the broker’s back office at any time and dissect every trade. This is obviously not the case, and many brokers do take advantage of this opaqueness, but the details of that are best left for another discussion.

So without further ado, let’s get into the details of how forex brokers function. Somewhat removed from the top-tier interbank market, retail forex brokers are there to provide a service that would otherwise not be available, that is, giving an investor with a $10,000 bankroll the chance to speculate in the up-until-recently very exclusive forex market. There are generally considered to be 2 types of brokers providing access at the retail level: Electronic Communications Networks (ECNs) and Market Makers. ECNs are generally somewhat more exclusive, requiring larger deposits to get started, but are seen as providing more direct access to the interbank market. As we will see, there are certainly advantages to this, but some disadvantages as well. Market makers, on the other hand are more often than not, the counter party to their clients’ trades, creating somewhat of a conflict of interest, whereas ECNs profit from commission fees charged directly to the clients, regardless of the result of any trade, they are seen as being completely impartial – an ECN has no incentive for a client to lose money. In fact, one could argue that an ECN stands to profit more if a client is successful, meaning that s/he will stay around longer and they will be able to collect more commission fees from them. A market maker, on the other hand, being the counterparty to a client’s trade, makes money if the client loses money, providing an incentive for some shady practices, particularly in an unregulated market. The extent to which this happens varies among individual brokers. There are also some benefits to trading with a market maker (see our ECNs vs. Market Makers article) Some brokers also provide a service that doesn’t quite fit into either category – they route different orders differently, depending on complex algorithms, or on a dealing desk, that analyze each order and attempt to fill it in the way that will be most beneficial to the broker’s bottom line. They can offset some client orders against one another, effectively creating an in-house market, they can choose to be the counterparty to a client’s trade (trade “against” the client), or they can offset their position with a hedge through a higher-tier counterparty. Note that the market maker is mainly concerned with managing its net exposure, and NOT with any single individual’s trades. They are NOT gunning for your stop losses specifically, but may be gunning for clusters of stops.

If you have already read the first article in the series, Structure of the Forex Market, you will recall that market mechanics are responsible for the variation in bid/ask spreads, and also for slippage. So it seems the two biggest novice traders’ pet peeves are not so much a function of who their broker is, but rather their lack of understanding of the way the forex market operates. A broker that offers a fixed spread tends not to fill orders during periods of low liquidity because this would expose them to undue risk, and as much as their job is to cater to their clients, remember they are in business primarily to make money for themselves. Some brokers also offer guaranteed order fills, such as “guaranteed stop losses”. Again, if there is no counter party to take the trade, they have to expose themselves to risk in order to fulfill this guarantee, so don’t be surprised if you see such a broker quoting different/delayed prices around important trend lines or support/resistance levels. Be especially aware of brokers who offer both guaranteed fills AND fixed spreads. When a broker offers something that seems too good to be true, you would be wise to question how exactly their business model is able to support such a risky practice. As a general rule, a broker will help you only when your interests are aligned with theirs. On the other hand, brokers provide a very valuable service, without which you wouldn’t have the opportunity to profit from the forex market, so please think about how it all comes together before blaming your broker for everything.

 

[boniez]

LOL its too long and difficult to understood, but i know the main point and thanks for the article if you really wrote that much,,,

but i think quite hard to maintain if we had own broker

[myregister]

LOL its too long and difficult to understood, but i know the main point and thanks for the article if you really wrote that much,,,

but i think quite hard to maintain if we had own broker

Instead forex brokers get earnings from the spreads and commissions, right? specifically for ECn, this type of brokers usually go give a very small spread with the compensation commission is quite interesting to follow, while STP works with giving a bit higher spreads.

[Alice Frampton]

I think Forex brokers basically works and survives on commissions, spread or other charges and that’s okay as long as they have given us clear transparent way of their earning as a bogus broker will earn only by scamming and cheating clients while a real broker will earn with the stuff I have mention above.

 

I am currently trading with OctaFX broker and they are a regulated broker and they earn only from spread that too a pretty low one of just 0.2 pips and that’s it they don’t charge any hidden fees and even they have swap free account so if we want even that won’t be charge so really getting such a honest broker is almost impossible in current times.

[myregister]

Comission and spreads actually, they earn money from that for ECN i see they earn with very small spread and comission. While for STP and DMA will earn mostly from spread without any comission. Their earning might be low but it seems that they don't get any loss if someone lose when using their service.

[shemoalaa85]

I think Forex brokers basically works and survives on commissions they earn money from that for ECN i see they earn with very small spread and comission

[myregister]

I think Forex brokers basically works and survives on commissions they earn money from that for ECN i see they earn with very small spread and comission

Yes, that is right that broker earn from comission or spreads or even both. One of the example just like you said ECN which earn from spreads which is low plus volatile comission, STP broker also earn but not from comission only from spreads which is also volatile.

[pepy]

@myregister: You forget that DMA also has chance to earn from spreads alone but in this case they earn in smaller amount. Not as high as STP but because they are working together with liquiditor, so it is just like one access to that liquiditor and in the end the fees for each transaction is less too.

[myregister]

@sidejob: For sure DMA has chance for do something like that this not a truly super secret, working together doesn't ring the bell but i think they have contract with liquiditors(not one but usually more than 4 liquiditors). STP is the most flexible over those all, as has been proven but their spreads is bigger and that's where they get money.

[pepy]

Oh! My mistake there it is more than one liquiditors and also i think DMA is actually better because of lesser spread that we should spend compared to STP, but ECN is the most effective , but DD broker love their client's loss while ECN or STP or DMA would never be much happy if the clients lose because it means maybe they will lose some stream after that

[myregister]

ECN the most effective? It is depend dude, trader that want more flexibility can choose STP and will say STP is the most effective type of brokers because it allows for higher leverage than what ECN can do, also brokers basically act as middleman between retail traders(us) and luqiditor which is the market maker.

[pepy]

Have you ever trade with ECN? Why ECN become more effective is because it is effective, it hasinterbank market access not like STP or DMA. ECN earns based on theri competitive price because of the liquiditor is easy to accessed by it and not to mention its low cost, well maybe not for scalping but for other kind of trading that is very good.

[myregister]

Yes it has interbank market but it is less flexible and usually some of them offers low leverage, you cannot even get up to 1:500. The highest i see is 1:200 . To be honest to trade in ECN bank give you biggest cost if you trade small, at least you must have capital at around 4 digits dollar and use at least 1 mini lot size, it will give you better insight of your trading.

[pepy]

Yes it has interbank market but it is less flexible and usually some of them offers low leverage, you cannot even get up to 1:500. The highest i see is 1:200 . To be honest to trade in ECN bank give you biggest cost if you trade small, at least you must have capital at around 4 digits dollar and use at least 1 mini lot size, it will give you better insight of your trading.

Not a big deal, if the market less flexible but you get the option to see the depth of the market i think you shouldn't worry about it, For leverage, well that is surely low but that is make sense since leverage means borrowing.In this case i think that we should have thought of big traders , or if we have much capital to trade then ECN could be a good place to choose.

[myregister]

Why i should worry about that? I mean the market is depth enough and i can even see more movements rather than others. Not to mention brokers work based on their own preference but basically is the same except for the dealing desk broker where it is possible them to change the course of market by theirselves because they are the market maker.

[pepy]

If you notice the difference between buy price and sell price then that is spread or a markup something which put by broker, if you trade in ECN it is lower but in STP or DMA it would be bigger. For broker that is their main income or to be exact that is the fees for that broker's service to give us connection to the market.

[Vaabum]

First of all - I advise you to study first. This aspect is extremely important for a trader. When I started working with a broker from AMarkets, I first used a demo account for training.