The 4 Types of Forex Brokers — Explained
And How to Determine Which is which
If you’re new to FX trading you might have heard that there are Market Makers and ECN brokers. However, contrary to popular belief, there are more than these two. If you did some digging you’d find that there are actually 2 more types of Forex brokers.
The 4 Types of Forex brokers
Ok, but what are they- I hear you ask. I’m getting to it. Don’t get your panties in a bunch.
Drum roll please.
Here they are:
- The A book broker (AKA Direct Market Access/Straight Through Processing[DMA/STP] or No Dealing Desk[NDD]) — despite some claiming that the DMA part is put there for marketing purposes (because it’s a simple, easy-to-understand term) it’s actually not the case. A DMA/STP broker will act as an intermediary between the Forex market and the trader. This is also known as agency-only model. In this case the broker makes his profit by charging the trader a fee for the order execution. It’s in the broker’s best interest for his traders to be happy and winning because this means they will trade longer with him. With this model a trader can be sure that the broker will do his best to provide the best trading condition because it’s of interest to both parties.
- The B book broker (also known as Market Maker or Dealing Desk) — a MM or DD broker is the kind of broker that accepts and fills all your orders. Thus he is essentially the counterparty in your trades. This means that your orders will not be sent to the actual FX market.
To put it in layman’s terms — when you as a trader lose, the market maker wins and vice versa.
To make things even worse for you, the trader, this kind of broker can see your account balances, orders and stop loss levels. And if that is not bad enough the Dealing Desk broker can manipulate the spreads, slow your order’s execution speed and refuse to fill your order by sending you requotes.
It’s like playing poker against the bank with your cards being transparent and them having to pick what cards you’re both dealt.
- The C book (also known as ECN or Hybrid model) broker — A C-book broker combines both A and B book broker techniques. It’s literally a hybrid model. The ECN broker can act as a Market Maker for smaller trades (low liquidity traders) and as an agency for larger amounts.
As far as business is concerned it’s the best of both worlds. Let me try to explain. Traders with smaller accounts (equity) are in most cases beginners and when the ECN acts as a Dealing desk it’s a surefire way to make his additional profits on top of the initial order execution fee. In some cases, an ECN broker claim that they operate solely as an agency, that’s when you, as a trader, have to take a look at the company and see if they own a bank. In which case they might as well be an agency but instead of sending your order to the open liquidity pool they would send it to their own bank to act as the counterparty for all trades, so yeah.
This is all grand from a business perspective, but from a trader/customer’s POV (point-of-view) that is a money-grabbing-get-rich-quick scheme that should be banned. And such brokers should be disbanded, dismantled and sent to the prison camps of North Korea to break rocks for a cup of rice a day.
Of course, not all ECNs will do that and there are exceptions.
- The Scam broker is the last and probably most commonly found “broker” type — it’s pretty much self-explanatory. This is a company made solely with the purpose of taking the money of new and inexperienced traders that might fall for it and would actually deposit funds to them. If you do a quick search on any search engine of choice by typing in “scam broker” you’ll find countless results. There are some telltale signs that should raise red flags when looking at such a broker but I’ll elaborate more on the topic below.
Before I get into the topic of identifying a broker’s type let’s talk about the advantages and disadvantages of each type.
Pros and Cons of the Broker Types
Pros of the A book (agency model) brokers:
- Highly motivated to deliver best trading conditions.
- No conflict of interest.
- No re-quotes.
- Positive slippage.
- Real market conditions (bigger liquidity pool).
- Fast order executions at best market conditions.
- Negative balance protection — most legitimate A book brokers will have it put in place.
Cons of A-book brokers:
- Variable spreads that could widen.
- Negative slippage.
- Higher trading fees in general.
Pros of B-Book brokers:
- Instant order execution.
- Fixed or minimal spreads.
- Low trading fees.
- Higher leverage.
Cons of B-Book brokers:
- Conflict of interest — they profit from your loss.
- They can manipulate the spreads, execution times etc.
- Often they will have only negative slippage enabled.
Pros and cons of C-book (hybrid model) brokers
From what I’ve written above, if you’ve even bothered to read it, you’d already know that they can have the pros and cons of both A and B book brokers. So, it’s hard to define their advantages and disadvantages because that depends on the way they’d decide to act when executing your order.
I`ll skip the pros and cons of scam brokers for obvious reasons.
OK? OK. Cool, moving on.
How to Identify Scam, Market Makers, ECN and STP brokers?
To state the obvious — It’s vital that you know what kind of broker you’ll be trading with. Simply because in order to start making money from Forex you have to trade with a good broker that suits your trading style and you don’t want to have to worry about your funds’ safety.
How to spot scam brokers?
One of the first things that should raise a HUGE red flag is if some random person on the net (that what we,the millennials,call The Internet, grandpa) hits you up and offers to double, triple, quadruple your money in a week,month or so. You just have to transfer funds to a broker that he’ll give you and he’ll tell you what to trade and when.
Some other things you should keep eyes open for:
- Bonuses — any type of bonus (welcome bonus, no deposit bonus, first deposit bonus, “you deposit, we’ll match your deposit” bonuses etc.)
- Lack of regulation or regulated by some exotic place like — Belize, St Vincent island, Marshall Islands, British Columbia etc.
The kind of place you’d want to go on a vacation, not to open a brokerage.
- Random bonuses and rewards/prizes like laptops, cars, apartments, vacations. (does not apply for competitions)
- Fixed spreads
- Lots of account types (and sub-account types) with different spreads and conditions
- Lack of regulation and licence number anywhere on the site. Or mentions that the broker is “self-regulated” (not honest enough to say, they are not regulated).
ALWAYS do your due diligence and check if the broker is really licensed and regulated once you find such a number on their site.
How to spot Market Makers?
Remember — every scam broker is a Market Maker but not every Market Maker is a scam.
It’s pretty much the same as above. This is one reason to be cautious when deciding to start trading with a dealing desk (DD) broker. The main differences that you might find is that a legit Market Maker will often send requotes and will actually be regulated with a trustworthy (inland) regulator such as FCA, BaFin, ACPR (to name a few). Another difference is that you would be able to find their physical offices. Last but not least — an legit MM would let you withdraw your funds upon request whereas a scam would not.
How to spot STP (DMA) Brokers?
Some of the features that will help you spot a Straight-Through-Processing broker are:
- Variable spreads
- Low number of account types (2 or 3 in general) — the most common ones I’ve seen are demo, live and institutional. However, some brokers may name them differently.
- Positive and negative slippage
- Negative balance protection — not a rule yet, but once the ESMA regulation kicks in on the 1st of August 2018 it will be mandatory for all EU regulated brokers, regardless of execution type. So, keep this in mind.
- Post trade transparency reports — if the broker is honest, it will not be a problem for them to produce such a report upon request. This should be the case if the broker is Market in Financial Instruments Directive (MiFID II) and Regulation (MiFIR) compliant.
Here’s some more information on post trade transparency reports
- No requotes — due to the orders being filled on a Fill-or-Fill basis on the FX market you should never receive requotes with STP brokers. Instead of a requote that is sent by the broker, at their own volition, you may experience slippage (a natural market “phenomenon”).
- Regulated (with an inland regulator).
How to spot ECN (Hybrid model) Brokers?
ECN — Electronic Communication Network — (nearly) full info — here
These are probably the easiest to find because they would advertise themselves as such.
Such an example is a post by forex.com’s official profile on the babypips forum and I quote:
It’s worth noting that for institutional traders, our parent company, GAIN Capital, offers ECN solutions through the GTX marketplace, where we do not take the other side of the trade.
However, for retail traders, FOREX.com is a market maker, because we believe market making is the best way to provide our retail clients with reliable pricing at retail trade sizes while effectively managing our own risk. We are fully accountable for every execution and don’t outsource that responsibility to a third party.
That said, you should always do your due diligence and DYOR (Do Your Own Research).
In conclusion — regardless of the broker that you may pick (apart from the scams) it’s important to do a few things:
- Check if they are regulated with a big authority.
- Check feedback for them on forums like ForexPeaceArmy, Babypips, MyFXBook etc… (use the search first)
- Verify that the withdrawals work, ask their support about the rules to make a withdrawal. Test with a minimum amount (if you can afford it).
- Look at the broker’s fees and terms of service.
Forex Regulators you can rely on
- United States: National Futures Association (NFA) and Commodity Futures Trading Commission (CFTC)
- United Kingdom: Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA)
- Australia: Australian Securities and Investment Commission (ASIC)
- Switzerland: Swiss Federal Banking Commission (SFBC)
- Germany: Bundesanstalt für Finanzdienstleistungsaufsicht (BaFIN)
- France: Autorité des Marchés Financiers (AMF)
- Canada: Investment Information Regulatory Organization of Canada (IIROC)
- Cyprus: Cyprus Securities and Exchange Commission (CySEC)
If the broker you’re looking at is licensed and/or regulated (NOT registered, there is a difference) is regulated by at least one if the regulatory bodies listed above, you can rest assured that there is a 99.99% probability that broker is legit.
And that’s all folks!