What Type of FX Broker Should You Have?

Joined : 23 Dec 2007 Posts : 239 Location : Nigeria

Today's commentary is by Sean Hyman, our Currency Director and editor of The Money Trader.

Good Day Currency Traders!

Forex brokers (or "market makers") come in two brands.

They have either a dealing desk model or a "no dealing desk" model. Once you know how they differ, you can see which is best for you.

What's Behind the Dealing Desk?
Dealing Desk model - This is where a forex broker has its own "in-house" trading desk that offsets your orders. In other words, they're betting against you - taking the other side of your currency trades.

These trading desks are hedging against poor traders, so they tend do quite well. They're also providing the liquidity you need to get in and out of positions when necessary.

However, because dealing desk brokers bet against all the positions coming into their firm, usually they don't want you taking longer positions. They don't want you to scalp the market either because it's too hard to offset their risks. Plus, they're taking on all of the risk and they don't have that much potential to profit.

If they allowed people to continually scalp or take longer term positions, then they might not do as well. However, aside from those two trading styles, they do quite well overall.

You'll tend to have more slippage on your orders with a dealing desk and more "re-quotes" of your currency pair. Slippage is the difference between what the price is when you click to buy or sell and what price your trade actually fills at.

Dealing desk brokers often require you to margin more to receive carry interest. This is also called "rollover" interest in the industry.

A dealing desk firm also tends to have wider spreads because they are taking on more risk as a firm. Your loss is their gain, and their loss is your gain.
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Why Trading is a Little Easier without a Dealing Desk
No Dealing Desk model - These tend to be best for most traders. Here's why.

There is no dealing desk. Rather, multiple banks place competing quotes onto the trading station. They are competing for your business as they try to give you the lowest buy and the highest sell price available. This also lessens your spreads between your buy/sell quotes.

There are many advantages to the "no dealing desk" model. It's the one I prefer because I feel there's not a bias against me profiting like there is in a dealing desk model.

Usually, there aren't any re-quotes and there's far less slippage over a dealing desk model.

"Re-quotes" happen when a broker has to confirm a price to you as still being valid. This typically happens in faster moving markets. However, it takes away a lot of the "tradability" out of it at those times. And that's what they're actually hoping you do...either don't trade at those times when they're taking on higher risks than usual or trade at the "less favorable" quote. However, they're not going to tell you that it's a less favorable quote.

With no dealing desk, your firm doesn't have a bias for or against your trade. The broker doesn't profit if you lose or make money. The broker profits because they take a piece of your spread (the difference between the buy and sell quote).

The no dealing desk model acts as a "pass through" to the inter-banks. So these inter-banks are taking on the risk.

You can take longer term positions because your broker isn't taking on the trade's risk.

"No Dealing Desk" Brokers Let You Be Successful
If you do "too well" in a dealing desk model, they've been known to close out your account. They don't need a good reason why either.

The same goes for scalpers. Start scalping in a dealing desk model and you'll be getting a phone call telling you they are putting you on "dealer intervention." This is where they have to delay your buys/sells to make sure that you have the "proper price."

(A scalper is one who is trying to take advantage of small discrepancies in the market in a very short amount of time. Scalping produces extra risk for a dealing desk firm that they are uncomfortable with.)

In other words, they are going to make it difficult for you to profit off of them. So you might as well close out your account with them.

Sean Hyman, Currency Director