Retail Forex traders should understand the broker execution model before opening an account with them and trading with real money. Forex traders typically place a buy or sell order – either manually or using an EA. Most traders are not aware of the various different process models in action between the time the order leaves the trading terminal and is actually executed on the broker account.
Typically retail Forex traders believe a particular strategy thinking they can be profitable – while most are able to succeed in short term, very few are able to stay above water for even a year. Broker disclosures clearly show that over 75% of retail traders lose money by trading Forex.
Large institutions and professional traders place as much importance to the trading conditions and cost of trading as they place on the trading strategy. Cost of trading is a hidden cost which is recurring and keeps adding up with every trade you place. Spreads, commissions, swaps and slippage all add up over longer periods to seriously affect your bottom line. While they seem microscopic when seen individually, a large part of the strategies profits will be eaten up by the trading cost.
Basically, there are two types of execution:
- Dealing Desk Broker (Market Maker)
- No Dealing Desk Broker (Market Execution, DMA, STP, ECN)
Selecting broker account type with the model which most suits your trading style and strategy. The major Forex Broker execution models every traders needs to know are :
Direct Market Access (DMA)
DMA Forex brokers link traders directly to the market where they can place trading orders with liquidity providers.
Straight Through Processing (STP)
STP Forex brokers pass all transactions electronically to execution venue without human intervention.
Electronic Communication Network (ECN)
ECN Forex brokers enable orders of traders to interact with the orders of other participants in the ECN. Participants could be banks, retail traders, hedge funds or other brokers. Participants trade against each other by offering their best bid and ask prices.
Order execution mode where the trader’s transaction is processed at the best price available on the broker’s trade server. There is no dealing desk involves and brokers using this model have significant volumes from their own clients to meet execution requirements of their traders. While many brokers may actually be operating in this mode, very few seem to declare this on their sites.
No Dealing Desk (NDD) accounts send all trades directly into highly liquid Interbank forex market which reduces their dealing spreads, execution times and also eliminates any risk of human error. NDD accounts do not experience re-quotes on orders during data releases or high risk events. Re-quotes has been a major factor in most retail Forex traders missing out on good trades or losing more than they intended to.
NDD brokers do not earn from the spread on trades, so they charge a very small commission for trading. In some cases, they may markup by increasing the spread slightly. The competition among brokers is very fierce and brokers are working hard to keep their spreads as tight as possible.
It is critical for traders to choose NDD accounts types offering low spreads when they are considering automated trading with EA or when the trading frequency is more. Low spreads accounts increases the over all success rate of a strategy by avoiding “stoploss” pops, giving best trade entry level and faster execution.
Market Maker or Dealing Desk
Market Makers create a market for their clients. The broker controls the prices at which orders are filled and traders of dealing desk brokers may not even see the real InterBank market rates. When the broker gets an order from the trader, they try to find a matching sell order from other clients or pass your trades on to its liquidity provider. In case there are no matching orders, they take the opposite side of your trade. Brokers earn from the spread without taking the opposite side of your trade.
Market Makers offer fixed spreads which are much higher that what is offered by No Dealing Desk Brokers. Typically Market Maker accounts are named as Standard account type or Fixed Spread account type.
This kind of accounts are mostly suitable only for manual or automated trades with large payoff. for example, when the trade has a gain of +100 pips, the higher fixed spread of 2 pips may be very significant. But the same will be significant if the trade was to gain +20 pips and the frequency of such trades higher.
Traders should be aware of potential conflict of interest involved when trading with Market Makers. Trade entry price offered may not be always be transparent or be at market price seen on the liquidity providers.
But not all Market Makers are bad. When the broker has a very large trader base and high volumes from their own sources, retail traders will be able to trade successfully without any issues.