What is a Forex Broker

A forex broker is a corporate entity that functions as an intermediary between a trader and the inter-bank currency trading market. Usually, the interbank currency trading market is a network major banks that trade forex between each other and obtain foreign currency on behalf of their clients. These banks function as liquidity providers, and usually forex brokers provide trading clients with market access to this network of banks either directly (ECN brokers) or indirectly via a dealing desk (market makers).

It is normal for a forex broker to offer their traders with pricing of currencies from these banks, as they usually have a relationship with several of them.

Functions of a Forex Broker

Entering a Stop Loss Order at GekkoMarketsWhat exactly does a forex broker do in the market?

a)    Traders cannot access the market directly. They have to go through a regulated channel, and this is where brokers come in. A forex broker provides the trading platform which serves as the gateway between the trader and the entire forex market, with its other participants.

b)    The broker will hold the trader’s funds in trust in a segregated account. These funds will serve as the capital on which trades can be made.

c)     The broker provides the leverage on which trades in magnified amounts relative to the trader’s capital are made. The forex market is a highly leveraged market, and for traders to be able to control large positions with a small amount of money, they must borrow on these positions from their brokers. The borrowed funds is known as the leverage.

d)    The forex market requires a large amount of liquidity. Ordinarily, traders with low capital cannot afford this liquidity. Therefore, brokers that function as market makers will provide liquidity by buying up large positions from the liquidity providers and re-sell these positions at fixed spreads to their clients. This therefore creates a lower entry point for retail traders, allowing these traders open accounts with as low as $200.

Types of Forex Brokers

Forex brokers are mainly classified into two categories based on the kind of brokerage services and order execution types that they provide. As such, we have the following:

a)    Dealing Desk (DD) brokers

b)    Non-dealing Desk (NDD) brokers

Let us take a look at the differences between the modes of opera of both types of brokers.

a)     Dealing Desk Brokers

Dealing desk brokers are also referred to as market makers. This is because the pricing that traders will receive on forex contracts are not obtained directly from liquidity providers, but are routed through the dealing desk where this department now fractionates the contracts according to the orders placed by traders. Trading directly with liquidity providers requires a highly liquid environment. So the market makers step in to buy off large contracts on both sides of the trading equation from the liquidity providers, and then split these contracts down to the level of retail traders, thus enabling traders with very small capacity to gain entrance into the market.

The job of the dealing desk is therefore to interface between the market and the retail traders. This creates an environment where the spreads on currency pairs remain fixed and the capital requirements on traders are reduced. The platforms provided by dealing desk brokers are highly user friendly and tailored to support trading operations from a group of the population who are not trained financial market participants.

Non-Dealing Desk (NDD) Brokers

The NDD brokers are also referred to as the Electronic Communication Network (ECN) or direct market access brokers. ECN Brokers provide traders with institutional-style pricing, directly sourced and provided to traders from the liquidity providers in the interbank market (usually banks). This gives a trader several price quotations to choose from, and the assurance that the orders will be sent back to liquidity providers for direct access processing and execution.

With the NDD brokers, spreads are variable and trades attract commissions apart from the spread cost. This arrangement which is based on high-speed protocols will demand a larger capital base. It is not unusual to see brokers without a dealing desk demanding for account starting capital of about $10,000 to as high as $100,000 on some forex broker platforms.

Conclusion

A loose category features brokers that operate a dealing desk, but provide special trade stations that allow traders the use of bridging software which has the ability to bypass this dealing desk and throw the orders to the liquidity providers directly.

Forex brokers are required to be regulated, since they hold traders’ funds on their behalf and essentially are responsible for maintaining the environment on which forex traders trade. So before you engage the services of a broker, it is essential to understand what type of broker you want to use, whether that broker is regulated, and indeed, the trustworthiness of such a broker.

Adam

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Adam is an experienced financial trader who writes about Forex trading, binary options, technical analysis and more.

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