There are two types of forex brokers: the forex broker model and the market maker model. This article will introduce these two models and how to distinguish between them.
A forex broker can be understood as a trading intermediary in the forex trading process, earning revenue through the spread or commission on trades.
Forex trading requires connection to the banking system, which is a significant barrier for individual traders. Forex brokers act as intermediaries, providing services such as connecting to the banking system, enabling individual traders to engage in forex trading. Under the forex broker model, all trades are executed in the actual forex market.
Forex market makers operate on a platform set up by market makers, where investors trade within the platform’s network; their orders are not actually placed in the forex market. Generally, in this model, the investor’s counterparty is the market maker, and their interests are in conflict. If the investor profits, the forex market maker platform will incur losses; conversely,
if the investor loses, the forex market maker platform will profit. The forex market maker platform’s profits come from the spreads of the investor’s trades and the investor’s losses.
The main difference between forex brokers and market makers lies in their trading models. Forex market makers execute trades directly, using STP ( Straight Through Processing) or ECN (Electronic Communication Network) models , where the broker’s and investor’s profits are relatively aligned. Forex market makers, on the other hand, have traders present who may intervene in investor orders. Their profits come not only from spreads but also from investor losses.
In market maker trading, the interests of the market maker and the investor are relatively conflicting. Furthermore, under the market maker model, investors may face certain restrictions on their trading, such as restrictions on using Expert Advisors (EAs) or frequent trading.
So how can you determine a forex broker’s business model? There are four simple and effective methods:
1. Does the broker allow ultra-short-term trading?
If a broker explicitly prohibits or restricts ultra-short-term trading, you can conclude that the broker is a market maker. This is the simplest and most effective way to determine this.
2. Does the broker restrict the setting of stop-loss levels?
ECN platforms allow investors to set stop-loss levels at any price point, whereas market makers impose a minimum limit on stop-loss levels.
3. Do they re-quote?
For highly profitable clients, market makers will avoid engaging in speculative trades with them; therefore, they must route orders to the real forex market to offset the actual liquidity, i.e., deal-or-discover (DD) transactions.
However, due to limited market depth and delays in order processing, by the time the client’s order is processed by the market, the price may have changed. If a trade is executed at that point, the market maker will incur a loss resulting from the price discrepancy.Obviously, market makers are unwilling to bear such losses, so they will reject the client’s order, re-quote the client, and require the client to place a new order or confirm acceptance of the new price.
4. Are there restrictions on how far a pending order can be placed from the current price?
Market makers typically not only restrict ultra-short-term trading but also impose requirements on the placement of pending orders. Near the current price, you can only enter the market using market orders, not limit orders.
Therefore, when placing a limit order, if you are prompted that it must be at least x pips away from the current price, you can be certain that the broker is a market maker. No legitimate broker platform would impose any restrictions on pending orders.
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