August 11, 2020, | AtoZ Markets – Every trader, whether new or experienced, knows that there are different types of Forex brokers. In this article, we will assist you in understanding the difference between CFDs brokers better, may they be ECN, STP, Market Maker, or be it a hybrid broker (a combination of ECN and STP). This guide aims to make it easier for every trader to understand the different types of Forex brokers better, how brokers process traders' orders, trade lot size you should trade with each broker if your broker uses dealing desks.
Unfortunately, new traders believe that every Forex (FX) broker is the same. Even worse, those traders who lost money will generalize the whole industry as a zero-sum game. Traders need to understand that every Forex broker is different. Even though they all would use MT4 as the trading platform, brokers are different! Regulators are also trying their best to reduce the scam in the industry, give better odds to traders (this could be argued, of course). All in all, Forex is becoming more like a business than a luck game at the beginning of the century.
How to identify a reliable Forex broker
At AtoZMarkets, we try our best while giving ratings at our Forex Broker Directory. We spend a significant Due Diligence process to avoid any faulty broker getting any good rating that they don't deserve. But, what should you pay attention to while selecting a reliable Forex Broker to trade with?
Reliable Broker qualification has multiple elements for us:
- Is your broker regulated?
Tier 1 regulation used to be on top of our list until 2017. However, with those of leverage restrictions and regulatory limitations, some brokers have also opened themselves to an offshore branch to accommodate traders' wishes. Despite this, we highly recommend traders using regulated Forex brokers. If your broker does not have a reliable license, be careful! Your money might not be safe.
Most of the tier one regulators have some investor compensation funds, aiming to safeguard traders in case of broker default. Additionally, these Forex regulators aim to make sure that brokers follow ethical limits while handling their clients.
List of Top 5 Forex regulators
- USA: The US CFTC and NFA (Commodity Futures Trading Commission and National Futures Association make sure that only authorized Forex brokers get to handle US citizens and residents.
- Japan: Japan FSA (Financial Services Agency) is in charge of Japan's Forex regulation. Majorly due to the leverage limitations, recently, many Japanese traders prefer to trade with non-Japanese FSA authorized brokers.
- UK: FCA UK (Financial Conduct Authority) is the top financial regulator in Europe, despite Brexit fears.
- Australia: ASIC is the primary financial regulator in down under; however, due to their ever-rising demands, AUSIE Forex broker applications are going down recently.
- Switzerland: FINMA is also leading the way with its regulation as SWISS trust has always been preached after ever since the WW2.
- EXTRA: Dubai's DFSA is the top preferred local regulator in the Middle East.
- What trading platform does your broker offer?
Although most Forex brokers offer MT4 (Metatrader 4) or MT5 as default trading platforms, traders should already know that not every MT4 is the same. Depending on your Forex Broker Type, you may have virtual dealers, intentional server glitches, and much more.
Different types of CFD brokers
While traders often hear Market Maker and non-Market Maker brokers, there are many different broker types:
- DD (Dealing Desk Forex Brokers)
- STP (Straight Through Processing) aka #abook Forex brokers
- ECN (Electronic Communication Network)
- Hybrid (ECN+STP).
What is a Dealing Desk Forex Broker?
Traders often call Dealing Desk forex brokers as market makers. The reason why these brokers are called market makers is these brokers will become your counterparty. Dealing Desk forex brokers will take the opposite order with their traders. Though some orders are being hedged, dealing desk brokers make their income from multiple resources:
- Spreads – Often DD brokers will offer fixed spreads
- Providing liquidity
- Connect different traders' orders before hedging
Dealing with Market Making brokers is not all bad if your account is specifically small. However, you should know that your broker will then have a conflict of interest with you. If you are using a scalping trading strategy, you should stay away from the Market Making Forex brokers.
It is also important to note that almost every broker who has a Market Making license will have STP and ECN accounts. So, a little research will help.
What is an STP Broker?
STP (Straight Through Processing) brokers do not have to have any dealing desk. All orders with an STP broker/account go through the broker's liquidity providers, and liquidity providers execute them at their bid/ask rates.
Who are liquidity providers?
STP brokers' Liquidity providers are often hedge funds, banks, and prime brokers.
One of the key benefits of STP brokers is the so-called DMA. DMA stands for Direct Market Access. Traders' orders go directly to the liquidity pool, so orders are filled out at the best possible price, with only a small mark-up spread by the broker. You should always aim for the broker with the most variable spreads. There is no way for the LPs to track each trader and have any conflicting prices.
Also, STP brokers are not able to offer any fixed spreads. The reason for STP brokers not being able to offer fixed spreads is the very nature of picking the best spread/ price for each order. As a result, STP brokers do not have any requote neither. STP accounts are most favorable for those traders using scalping trading strategies or news trading strategies.
What is an ECN Broker?
STP and ECN brokers have a lot of similarities. However, the most significant difference s the routing of the client orders. In recent years prime brokers are emerging and connecting multiple liquidity providers under one hub to give better and faster liquidity pools for brokers.
These liquidity hubs act as one liquidity source. The prime hub acts effectively as a significant liquidity source. The biggest issue here is that you may also go through a market maker broker on the other side of the ECN network.
Another difference between the STP and the ECN is that most ECN trading is usually will have a minimum order size of 0.1 lot size. It is because very few LPs will allow less than0.1 lots.
What is a Hybrid Model Forex broker?
Since traders want different things all the time, brokers have come up with a Hybrid model broker type. These brokers can offer STP, ECN accounts, and, at the same time, be able to become a DD broker.
Conclusion: Which broker type is the best?
In conclusion, there is no one answer to call one broker type being superior to another. Each broker type meets the needs of a specific group of traders.
At AtoZMarkets, we recommend dealing with those Forex brokers that offer market execution with no requotes. Professional traders recommend avoiding brokers using virtual dealers. Most importantly, if something smells fishy or too good to be true, then it probably is.
Think we missed something? Let us know in the comment section below.
This article was updated by Samson Ononeme on August 11, 2020, and originally created on April 07, 2019.