One of the first steps any trader should take is to choose their broker. This is an important decision that must be carefully considered. There are several different types of brokerage models, but in general they generally fall into two main categories – dealing desk and non-dealing desk. In today's article, we'll take a closer look at each of these models so you can decide which type is best for your trading style.
Model Non Dealing Desk
The Non Dealing Desk broker uses prices from other market participants: banks, financial institutions, and sometimes other traders, to create bid and ask quotes.
These market participants, also known as liquidity providers or market makers, send their prices through an electronic network. Prices are updated in real time and there are no referrals. There are two types of networks: ECN (Electronic Community Network) or STP (Straight Through Processing).
Essentially, these brokers are aggregators of prices that they collect from various sources to then provide the best price for their clients. When you trade with these brokers, the liquidity provider takes over the other side of the trade.
In this case, the broker can quickly fulfill his client’s order at the current price. In this scenario, the broker acts as an intermediary, accepting an order from its client and executing the order as requested by the liquidity provider.
ECN includes multiple liquidity providers as it can process hundreds of orders simultaneously for the same currency pair. STP is also an electronic network, but it cannot handle as many prices and quotes as the ECN model. STP goes directly to several banks and other financial institutions.
The diagram above shows the dynamics of prices coming into the broker's electronic platform (black arrows), which then shows the client the best available buy and sell price (gray arrows). The electronic network allows the broker to receive the client's order and execute it based on the counterparty's price quote (blue arrows).
Model dealing center
The term dealing center is used to define a broker who does not execute his clients' orders at the prices of liquidity providers, but takes the reverse side of the transaction on himself and, therefore, is the client's counterparty.
Depending on the direction of the trade, the size and condition of the market, the brokers themselves will decide whether they will trade directly or not, and at some point they may transfer their positions to a market maker. If the market rises, they may decide to close the trade immediately at the best price available from one of their liquidity providers.
These types of brokers may also use the STP model as it allows them to execute orders efficiently when they do not intend to hold the other side of the trade. However, you will not necessarily receive prices from liquidity providers through the broker's interface, since the broker has yet to decide whether to hold its position against you. The dealing desk can also combine the positions of different traders into a common pool of orders.
Most liquidity providers quote currencies on the interbank market and are unwilling to trade for less than $100,000. Consequently, a dealing desk broker who provides liquidity to retail traders will have to take the other side of its clients' trades, if they are small, until it accumulates a position large enough to fill an order with one of its liquidity providers.
The picture above shows the price movement for a dealing desk. Prices from liquidity providers are used to create buy or sell quotes (black arrow), then the broker passes the resulting price to its client (gray arrow). The client can trade at these prices (blue arrow) usually electronically using STP. The broker's platform then passes the trade to the dealing desk (green arrow).
The dealing center decides how to manage the transaction. It may be accumulating client positions, or it may have enough volume to exit a position directly with its liquidity providers (orange arrows).
The dealing center can also indicate its own prices, since it holds the positions itself. These prices will be reflected in quotes from its clients (red arrow) or liquidity providers (yellow arrow).
Non Dealing Desk: characteristics and features
The most important feature of Non Dealing Desk forex brokers is the fact that they offer the best bid-ask prices in the market. Since they have access to various liquidity providers, they offer market prices to their clients for an additional commission.
Commissions are the main source of income for these brokers since they never open their own positions. The bid-ask spread will also be variable because it will depend on the quotes of many market participants.
ECN and STP models offer the best prices. However, ECNs have access to a much larger range of prices than STPs and can offer tighter bid-ask spreads than STPs. Since this type of broker offers the best price for their clients, they must charge a commission since they give the opportunity to open positions at the market price, without a markup.
The concept of ECN and STP is quite broad and many brokers can say that they offer the best price on the market. It is enough to be connected to many clients who access the platform and create an ECN network, although they may not necessarily be tier 1 banks or financial institutions.
The ECN definition means that the broker matches your order to find the best price from other clients or liquidity providers.
Banks do not offer liquidity with small bid or ask spreads for small lot sizes. Most of these financial institutions will only quote hard prices for minimum position sizes equal to standard $100,000 lots. This means that brokers with real access to market makers and their liquidity cannot offer accounts that allow small lot trading. If a broker offers mini, micro or cent accounts, typically with extremely high leverage, it is most likely a dealing desk.
As a rule, full-fledged brokers offer account opening with an initial balance of at least $1000. Some require even higher amounts, such as $5,000. Leverage is also limited, rarely exceeding 10 to 1. These account sizes are necessary since mini and micro lots are usually not supported here.
Dealing center: features and nuances
Dealing centers, as a rule, provide the opportunity to trade mini, micro or cent lots. These brokers also have access to market makers and liquidity providers. However, they do not pass on the price directly to their customers. Since they do not charge commissions, they rely on their clients' losses to make profits, as well as income from the spread.
If a client is trading a large enough lot, the broker can fill his position directly at the market maker's price. If a broker has a client who wants to trade 10 lots, he can get the best price and minimum spread.
When trading small positions, dealing centers cannot provide market maker prices. In this case, the broker takes the opposite side of the transaction. In doing so, they also accumulate their clients' positions and profit from the spread.
Some dealing centers offer more personalized service that can solve customer problems or provide them with more knowledgeable support.
Advantages and disadvantages of each model
In terms of spread size, the Non Dealing Desk model remains unrivaled. These brokers can rely on the extensive ECN network of banks and other market participants to provide the best available price to their clients. However, you will be charged a commission for each transaction. Dealing desks will have wider spreads, but will not charge you additional commission.
There are many contradictions regarding the possible conflict of interest of a dealing center, where the broker is the counterparty to the client's transactions. If you make money on your trading, then the broker loses money. This is true up to a point. Sometimes a broker can match your trade with other clients who have entered trades in the opposite direction.
Dealing center or Non Dealing Desk: what to choose?
The forex market is the largest unregulated financial market in the world, and this situation is unlikely to change anytime soon. Most regulated financial markets are controlled by exchanges, where close supervision and auditing occur at all times. Here, market participants and investors are protected by the state.
However, the best choice for one trader may not be the best choice for another. This issue should be considered as part of your trading style. But there are three main factors to consider:
- The size of your positions.
- Frequency of trading.
- Quality of service.
If you are a small retail trader, you have no choice but to go to a dealing desk. The problem that can arise here is requotes. You click on the buy button, only to find that the price has moved, usually against you, and you are asked if you still want to make the trade. If this happens too often, you may want to try a different broker.
The frequency of your trading will determine how much you are willing to pay for spreads. Typically, the spread varies depending on market conditions. Most dealing brokers tend to have wider spreads than Non Dealing Desk brokers. However, it is worth remembering possible commissions.
Ultimately, traders should choose brokers that are well regulated. The US, UK and European jurisdictions offer a very high level of control.
While there is no doubt that ECN brokers offer better pricing and order execution transparency, I would argue that the risk of rigging or other dishonesty on the part of most dealing desks is a relic of the past and an exaggerated myth.
In the long term, a well-established broker wants its clients to be successful and continue trading for as long as possible. Regardless of whether a broker charges a commission or makes his profit from the spread, he always makes money on his clients' trades, whether those trades are losing or profitable.
