First, who is a broker? A broker is a bank-like business that allows you trade on the forex market. The forex market was initially created for big businesses and countries. Therefore, the minimum amount traded on the market was exceptionally huge (your whole life income and savings might not help you trade on the market at that time). Therefore, for individuals like me and you with peanut money (in comparison to the huge businesses) to be able to trade on the market, then there was the need for money conscious individuals to come together to profit from the market gap.
michaframp, why this long talk? Are we here to learn about the history of a broker? Patience please. How can you trade if you don’t have patience? My friend, let me show how much I know about the business I am involved in. Skip if you have coffee in your dress. It will help you relax.
Okay, so, a broker is a firm that holds your trading account, quotes prices and send your trades to the market. Without a broker, then you will have to probably send your USD to Japan to exchange like we used to do in the barter trading times. (Maybe you won’t have to buy a ticket)
There are three (3) main types of brokers.
- Market maker. This broker has the forex market in their building. In order words, they don’t care what other people are doing on the market. They set their own bid and ask prices and do as they want. They don’t send your trades to the market. Basically, the forex market is a big market maker. Without market makers, there will be no market because they accept your buys (by selling to you) without any question and vice-versa (I don’t know the difference in using vice-versa and opposite in explanations like this. I believe you understand though). They are also referred to as dealing desk brokers.
- Electronic Communication Networks (ECN). These brokers care what goes on at the other side of the market. They therefore receive pricing from different institutions on the interbank market. They then quote the best price for you to trade. They then use their communication networks to match your orders with the best price provider available at that time. This broker makes money by adding an additional commission (usually a percentage) on the spread quoted from the best provider. So let’s say, the provider gives a spread of 0.3pips on EURUSD, an ECN broker will add his spread of say, 0.2 pips. So the forex trader trading with this ECN broker will receive a spread of 0.5pips on EURUSD. The extra 0.2pips is what the ECN broker earns and that is how they are genuinely supposed to make money.
- Straight Through Processing (STP). This broker is a combination of a market maker and an ECN. This broker, most of the time, displays its own quotes (prices) which are usually a reflection of the interbank quotes.
Sometimes, this broker will act as a market maker by keeping your trades in-house (as a market maker) and other times too, sending it to the market (as an ECN)Successful traders and robots or algorithm trades are automatically sent to the markets while small and losing client trades are kept in-house. This helps the broker often make a profit in both ways. On the trades sent to the markets, the broker earns his commission (spread) without sustaining any loss. On the trades kept in-house, the broker knows that in the long-term, losing and small traders are most likely to lose all or significant part of their capital, and these trades will come into the pockets of this broker since the trades are kept in-house. This means that, the broker trades against you and hopes that you lose so he makes money.In all, an ECN or STP or Market maker is not a bad broker. A bad broker is one who deliberately alters your trades, or market conditions or other conditions just to make sure that a trader loses most or part or all of his or her trading capital. There are forex scammers under each of the broker types listed above.
Brokers have regulatory bodies depending on where they hold your account. Popular regulatory bodies include
- Financial Services Authority (FSA) in the UK
- Cyprus Securities and Exchange Commission (CySEC) in Cyprus
- Commodity Futures Trading Commission (CFTC) in the US
These regulatory bodies ensure that your brokers deal with you in a fair and legal way. Any broker who deals unfairly with a trader stands the risk of losing his license if found guilty. Your duty as a trader is to make sure to check the regulatory body of your broker.
Your broker should be researched into very well before opening an account. A bad broker will swallow your hard earned money. The best place to know if your broker is good or bad is to read reviews made on them. Also make sure to visit your brokers website and read all the terms and services they propose to offer (I know that is really hard to do, but it is better to do it when you still have your cash than when they have used it to get turkey for thanksgiving).
Finally, if you want more information on the regulatory bodies, you can visit here.