Types of Forex Brokers

Forex broker is a company that helps traders enter the foreign exchange markets in order to make transactions. Brokers are serving as intermediaries between private investors and large international companies. In this article, you will find out about the types of brokers, their main differences and what models they work with. In addition, you will learn about the methods of order execution, types of trading accounts, and trading conditions.

A-book and B-book brokers. Difference between A-book and B-book brokers

There are two main models which Forex brokers use: A-book and B-book.

In the B-book model trades are not transferred to the real market. B-Book brokers operate based on the Dealing Desk (DD) system. These brokers are referred to as "market makers". Fraudulent brokers of this kind are sometimes called “forex bucket shops”. Trades are not passed through to the interbank market, and price movements are formed within the company by the broker itself.

"Market makers" provide both buy and sell quotes. DD brokers often assume the role of counterparty to the client. That is, they take the other side of the transaction with a client, and therefore it is beneficial for them if clients suffer losses. Due to conflict of interests, these brokers are not popular within the traders community. DD brokers or market makers usually provide fixed spreads and make their profit from the spread markup.

The largest liquidity providers are called prime brokers. Prime brokers are often investment banks or other large financial institutions. They carry out transactions on the interbank market on behalf of small brokerage companies. They also insure the risks of all trade parties.

The A-book model means that trades are transferred to the real interbank Forex market. These brokers use the Non Dealing Desk (NDD) system. They do not become counterparties of their clients, because they are taking the role of intermediaries between the market and traders. A real NDD broker does not allow price requotes and provide low floating spreads. Since the spreads are floating, they can widen significantly in times of high market volatility during important economic news releases. To make their profit, NDD brokers can use an additional margin markup or charge a commission on every Forex trade. There are three types of NDD brokers: STP, DMA, and ECN.

What are STP, DMA and ECN brokers?

Straight Through Processing (STP)

STP brokers directly transfer trade orders to their liquidity providers – large financial institutions that trade among themselves and thereby create the Forex market. Most STP brokers work with multiple liquidity providers.

Direct Market Access (DMA)

DMA accounts also transfer order information directly to liquidity providers. The difference between the processing of DMA and STP trade orders is that the DMA system automatically selects the best buy/sell price from all prices provided by liquidity providers at the time of the trade opening.

Electronic Communication Network (ECN)

ECN brokers process all clients' transactions on the interbank market. Such brokers may charge a commission for opening new trades as a fee for access to the trading platform. Most ECN brokers provide price information to all participants on the foreign exchange market as a means of increased market transparency. Such networks collect information about orders from all liquidity providers and gather this information in the Depth of Market (DOM) instrument. “Depth of market” is a tool available on trading platforms that displays the prices and volumes of buy and sell orders of other market participants.

Types of order execution. Market execution and instant execution.

In this article, we will look at two types of trade order execution: Market Execution and Instant Execution. We will figure out when they are used and how they differ from each other.

Instant Execution

Instant Execution is an execution type where a client places an order and specifies both volume and price. The order will be processed instantly if the price at this moment matches the one specified in the order. This allows the trader to plan the exact entry point and stick to the chosen trading strategy. If the price changes at the moment when the trader opens the transaction, it will not be executed. In this case the broker will offer the client a "requote", which means to make another request to open/close the transaction at a new price. This request can be cancelled by the client.

Requotes are considered to be a big disadvantage, as traders can receive multiple rejections and miss the desired time to open a trade due to a rapidly changing asset price. This type of execution is usually used by B-book market makers who work on the Dealing Desk system and use a fixed type of spread. You can find more information about requotes in the article "What are requotes and why do they happen?"

Market Execution

Market execution is a type of execution in which the client when placing an order only indicates the volume of the trade. If at the moment of opening the order cannot be executed at the indicated price, the broker will automatically execute it at the next available price.

The main difference from instant execution is that the broker does not reject the client's request in the event of a price change, but rather executes the order at the current price. This happens because a certain amount of time elapses between the moment the client opens a trade and the moment the liquidity provider's order is executed, during which the price can change. The price can be either lower or higher than the price indicated in the order. This process is called "slippage". The final price is calculated by taking the required volume from the depth of market at the available prices. A-book brokers with NDD model (STP/ECN) use market execution. Market execution types of accounts usually have floating spread. You can find more information about slippage in the article "What is Slippage on Forex?"

A large number of forex brokers are currently advertising their services on the market. They can differ in the type and model of the order execution. In a highly competitive environment, brokers often launch advertising campaigns aimed at attracting new customers. Each novice trader should carefully think over his own trading priorities and carefully analyze the conditions provided by brokers in order to choose the most suitable one for cooperation.