Forex brokers are an essential part of forex trading; they facilitate forex transactions for retail clients and earn profits from the spread between the bid and ask prices.Forex brokers are primarily categorized into two models: the Dealing Desk model and the No Dealing Desk model. Each has its own distinct characteristics in terms of trading mechanisms, pricing structures, and revenue models.
(1) Market Makers
- Trading Model: Market makers are dealers that operate under the Dealing Desk (DD) model, which is the primary trading model in the retail forex market.In the DD model, there is typically a back office staffed by traders to process forex orders. Clients do not execute orders directly with the bank; instead, the broker must participate in the client’s trades by “making the market,” which means taking the opposite position to the client’s trade.
- Pricing Mechanism: Under this model, the bid and ask prices displayed to traders differ from the actual prices in the interbank market. This is because the broker trades in the opposite direction of the client’s order to control the price.
- Revenue Model: Brokers generate revenue through spreads. When traders incur losses, market makers can also profit. When you buy a currency pair from a broker, the broker first matches your order with an existing order to sell the same currency pair.If there is no matching opposite order, the broker will enter into an opposite (hedging) trade with the client. In other words, when a trader buys, the market maker sells. If the client incurs a loss in the market, the broker can profit by “making the market” with a position opposite to the client’s.
(2) Straight-Through Processing (STP) Forex Brokers
- Trading Model: No-Dealing-Desk (NDD) forex brokers operate under a model without a back-office processing system. Since individual forex traders cannot directly trade on the interbank market, NDD forex brokers serve as intermediaries between individual traders and banks.No-Dealing-Desk forex brokers have no back-office processing; client orders are sent directly to liquidity providers for execution in the interbank market, resulting in fast order execution.
- Pricing Mechanism: The broker selects the best available price from quotes provided by various liquidity providers.Different STP trading platforms have varying numbers of liquidity providers. By forming partnerships through contracts with liquidity providers, brokers can select the best bid and ask prices from among the quotes when executing trades. However, if a broker has only one liquidity provider, the bid and ask prices will be determined entirely by that provider.
- Revenue Model: Brokers generate revenue through spreads. STP brokers offer both fixed and variable spreads. When a broker has only one liquidity provider, the spread is virtually fixed.When a broker has multiple liquidity providers, it can select the best bid and ask prices from among them, resulting in a floating spread. By adding a small markup to the spreads offered by liquidity providers, the broker generates revenue.
(3) Electronic Communications Networks (ECN Model)
- Trading Model: The electronic communications network operates on a No-Dealing-Desk (NDD) model. It is an electronic trading platform established by a forex broker to facilitate transactions between clients, banks, and other clients.Client orders are transmitted directly from the electronic trading platform to the foreign exchange market, where market participants (including banks, hedge funds, and other clients) publicly display their quotes within the system. The platform then automatically selects the best available price from among these quotes to execute the client’s order.The broker does not participate in clients’ trades but merely acts as an online intermediary; this model is characterized by a high degree of transparency.
- Pricing Mechanism: The electronic trading platform automatically selects the best price based on client orders in the system and quotes from various banks. Opposite-direction orders in the system are automatically matched with client orders, and clients can also view buy and sell orders from other market participants on the platform.
- Revenue Model: The electronic trading platform operates on a floating spread basis; the broker does not participate in clients’ trades and generates revenue solely through commissions.
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