A forex broker is a business that facilitates electronic (online) buying and selling of currencies for speculative purposes by mostly individual traders, small professional traders / "money managers" and small businesses.
Online forex brokers are regulated by financial market regulators and do not exchange currencies physically like Bureaux de Change.
Forex brokers are also called retail forex aggregators because they allow individuals to trade in much smaller amounts than banks and institutions in the Interbank market. Some retail brokers gather many small trades together and then offset it in the larger market. Others pass all trades directly on to larger liquidity providers.
Market Makers | Dealing Desk Brokers
In the very early days of online forex trading all forex brokers were "market makers". A market maker is a financial market professional who provides simultaneous buy and sell quotes to clients and execute resulting client orders. They are also the counter party in the transactions with their clients.
The market maker has several options of what to do with positions:
They can keep it in their "inventory" for a time, or
match it with other client orders, or
offset (hedge) it with their own liquidity providers.
To do all of this efficiently market makers need their own dealing room and dealers as they are the link between their retail clients and the larger institutional market and they take trading / market risk in the process.
A dealing desk operation is quite sophisticated and expensive and as transaction sizes in retail forex trading plummeted from 100K, to 10K to 1K this business model came under more and more pressure.
Due to technology advances streamlined volume driven models without dealings rooms were developed and are you as likely today to come across an experienced and well-regulated market maker in a major money center (London, Singapore, New York) as a new, marketing focused non-dealing desk forex broker incorporated on a sunny, low regulated Pacific island.
No Dealing Desk (NDD) Brokers
“No dealing desk” brokers are middle men – they get your order and pass it on to an actual dealing desk to be executed. They, however, are contractually your dealer or counterparty to the trade; they then face the other dealer with a corresponding trade. A more accurate description of this model would be to call it a pass-through dealing desk. The pass-through dealing desk “passes” the customer’s order to another dealing desk.
In the NDD model the forex broker still provides price quotes on their trading platform. Hower they source prices from liquidity providers, and add a markup for their traders. In this case the NDD broker, unlike the market maker, doesn't take any market / trading risk. Their revenue is strictly from the spread (difference between buy and sell price) the clients trade on less a fee / spread charged by the liquidity provider. Since they don't have any other revenue options they are particularly dependent on high volume trading by their customers.
These technologies are quite sophistaced and very stable and can be outsourced if needed. This allow the NDD broker to focus much more on trading volumes generated by trading clients, thus their focus is solely on marketing instead of market making!
In a non technical sense this is also a pass-through model with some bells and whistles added. An ECN is a "Electronic Communication Network".
Prices are sourced from different liquidity providers
The ECN broker provides a view to market depth (at what prices what volumes are available)
The ECN broker clients can directly trade on market prices and also provide prices
ECN brokers charge a fee as spreads are not marked up
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