Understanding of various types of Forex Brokers & their difference is very critical for a start up forex broker to pick the right forex brokerage business model. It is equally important to all Forex Traders to understand how different type of forex brokers work before picking who to trade with.

Most of start up forex brokers pick one of the popular and Best Forex White Labels Solutions like MT4 White Label & MT5 White Label as forex brokerage technology. The Trading Platforms like MT4 & MT5 usually remain common across different forex brokers.

There are various elements that differentiate between different Types of Forex Brokers. But the key differentiation that Forex Traders, Master Traders & Regulators care the most about is the type of “Order Matching” mechanism that a forex broker deploys.

ORDER MATCHING

“Order Matching” ideally means matching Buyers & Sellers at best possible price, quantity and cost. For every Trade to take place, we need at least 2 parties: Buyer & Seller! To fill an order there has to be a counter party that would take the other side of trade.

For example, if you want to Buy “x” quantity of an Instrument at a specific price, there should be one or more counter party that sells you it in your specified price and quantity. Same goes for a Sell order!

Let’s understand it using following illustration for Currency Pair EUROUSD:

PARTY A PARTY B
Order TypeBuy Order Type Buy
Currency PairEURO-USD Currency Pair EURO-USD
Price1.10278 Price 1.10278
Quantity1 Lot Quantity 1 Lot

The best case scenario is when buyers could buy full quantity of a security at the lowest possible price and cost on the other hand a seller is able to sell full quantity of a security at the highest possible price and low cost.

This constant buying and selling makes the market. Any market is called highly liquid if buyers and sellers are able to enter into a position and exit the position whenever they want at best possible price and cost.

Job of trading intermediaries like stock exchange, brokers etc. is to provide participants with a highly liquid trading platform at lowest possible cost.

To conclude, Order Matching is one of the most critical thing for any Forex Brokerage Business. It’s similar to a Pizza Delivery Business where orders are collected over the call/counter and then it’s processed in kitchen to provide the best and fasted delivery of order.

Choosing the type of Order Matching Mechanism is critical for Forex Brokerage Business because all the revenue generation possibilities revolve around the order management. Choosing the Order Matching Mechanism simply means;

  • Deciding how the orders of traders will be “filled”?
  • Who actually will take the other side of trade?
  • What charges and cost to be levied on traders/clients?
  • What technology solution like MT4 Liquidity Bridge would be needed?
  • What kind of vendors or partners would be required?
  • Cost & Revenue Opportunities Assessment for Forex Brokers.

Types of Forex Brokers

There are primarily 3 ways orders of a Trader can be filled and this is what defines the Forex Brokers Types:

I. Market Maker / Dealing Desk

II. No Dealing Desk

  • ECN (Electronic Communication Network)
  • STP (Straight Through Processing)

III. Hybrid

Forex Brokers Types: ECN, STP, Market Maker, A Book, B Book, Dealing Desk, No Dealing Desk | How they work | Differences, Pros-Cons for Brokers & Traders
Pictorial View of Different Types of Forex Brokers

Lets understand the difference between Dealing Desk v/s No Dealing Desk brokers or Market Maker v/s ECN v/s STP v/s Hybrid

MARKET MAKER / DEALING DESK

This is one of the most basic Order Matching Mechanism for Forex Brokers. Orders of Forex Traders are filled in following 2 ways:

ORGANIC

This is the most idealistic Order Matching Mechanism for all kind of Securities Markets including stock market, bonds market, mutual funds, and forex trading etc. wherein other side of trade is taken by other trader or investor. The liquidity is so high that traders are able to freely enter into a trade and exit it at their price and quantity without waiting. Organic Order Matching takes place when all the orders are pooled together and matched with best possible counter parties without involvement of a third party like Liquidity Providers. 

Organic Order Matching implies to other order matching processes as well at broader level. But let’s first understand how does it happen at the source; the Forex Broker itself!

What’s in Organic Order Matching for Forex Traders/Clients?

  • Trust & Credibility: Forex Traders trust the Organic Order Matching the most because the other side of trade is being taken by someone neutral like them. They get skeptical when the counter party to their trades is broker himself or a liquidity provider. And there is reason for that. Will explain this in next point.
  • Cost of Trading: is usually low because there isn’t any other third party who would add their mark up or charges.
  • Speed of Order Execution: is quite high because there is no manual dealing desk that would place the opposite side of trade manually.

What’s in Organic Order Matching for Forex Brokers?

  • High Trustworthiness: As explained above, traders trust Organic Order Matching the most and the brokers that could offer it would be highly trustworthy. As soon as traders find out you match order organically, they would line up to trade with you.
  • Revenue: Brokers generate revenue by applying maker-taker charges, swap charges, brokerage etc. depending on what your business model is.

DEALING DESK

It’s the most popular Order Matching Mechanism for Forex Brokers. Here other side of trade is taken by the broker itself. Which means when traders place a buy/sell order, broker fills the order by taking opposite side of trade.

There used to be a Dealing Desk at every forex brokers back end which consisted of operators who would feed the orders to traders and create the market. They would take the opposite side of trade against the orders placed by clients.

It used to be manual activity which has been mostly automated with the use of software and tools. The Dealing Desk works on following premises:

  • Forex Trading like other securities’ trading is ZERO Sum game which simply means a traders profit is loss to the person or party who took the opposite side of trade and trader’s loss is gains made by the other party.
  • Most of Forex Traders lose money while trading. A general estimate suggests this number to be anything between 80-95%. That means:
    • Only handful traders actually make money trading into forex
    • The losses made by majority of traders go to these 5% which consists of pro traders, brokers and liquidity providers.
    • Most of beginner traders lose money and blow up their accounts over and over again several times before they either become profitable or quit Forex Trading.

Hope its crystal clear why most of Forex Brokers dream of running a Dealing Desk or B-Book. They just want to make the most out of their Forex Brokerage Business. If most of their traders are going to lose money to someone, why not the brokers get to earn!

Just in case you are wondering if it’s legal or illegal for a Forex Broker to take opposite side of their clients’ trade. The answer is, it’s perfectly fine provided broker tells about this in advance to its clients.

If you are arguing that Forex Brokers should not take opposite of trade or run B-Book, here is the justification; a Forex Brokers job is to provide highly liquid trading platform. And when a client/trader is placing a Buy/Sell order, there should be someone to fill the order whosoever it is.

A client/trader decides for itself whether to enter into a trade and in which direction for what quantity. No one’s forcing him/her to take the trade. When they are right about the trade and make money, the other party loses the money they get in profits and vice versa.

What’s in Dealing Desk for Forex Traders/Clients?

  • Trust & Credibility: In plain words, Forex Traders don’t trust and rely much on B Book Forex Brokers. They believe that since entire system is run & controlled by their broker, there could be malpractice if broker takes opposite side of trade and starts losing money. In several Forex Forums, traders have been sharing stories of how their broker turned a profitable trade into loss by manipulating the system. Although, it’s not easily verifiable but these stories keep making rounds among the forex trader community and scares many traders.
  • Cost of Trading: It is usually low because there isn’t any third party who would add their mark up or charges. Most of B Book Forex Brokers rely mostly on losses of their clients for profit and offer huge discount on brokerage fee and other charges. They rely on stats of most of traders losing money to make profits. But few brokers really get greedy and want to make money every way possible by levying all possible charges.
  • Speed of Order Execution: is usually low because the Dealing Desk operators need to keep an eye on who is making profits and who is making losses to take positions accordingly. They may need to hedge their positions against the profitable traders. This usually makes the Price Quotation and Order Execution slightly slower. But you need not worry much there are few forex brokerage technology providers who have developed systems that can fully automate the B Booking process for you.

What’s in Dealing Desk for Forex Brokers?

Difficulty in Customer Acquisition: As explained above, Forex Traders usually don’t have high trust on B Book Forex Brokers which makes it really difficult for them to acquire new clients/traders.

Here is the list of 6 simple things B Book Forex Brokers can do to win the confidence of Forex Traders:

  1. Clearly state that you are a B-Book Forex Broker
  2. Explain them how B-Book is better for the Liquidity thereby ease of entry into a trade and exit for them
  3. Wave-off most of charges associated with Forex Trading like Brokerage, Slippage, Mark Up etc. If that doesn’t make financial sense, keep them as low as possible
  4. Train the support staff and be quick to respond to any complaints and queries of your clients. Keep the communication clear, state the timeline for resolution and abide by it. Response time should as low as in minutes.
  5. If the outcome is negative for your client, make sure to show the proofs like screenshot, ledger etc.
  6. In case of doubt, make the decision in your clients favor even if it takes you to refund money to your clients

Do these things and you will win over the confidence of your clients. These same clients will become you brand ambassador and spread the word out to the forex market that how great a Forex Broker you are. It might look slow but it’s steady and works wonders in long term. You of course need to be there for long haul to follow this strategy.

Revenue: Forex Brokers think they can make most of the revenue by running the B Book, always! But that’s not so easy and simple. You need to be careful with Risk Management skills and tools to make the profits and keep them too.

Cost Savings: They say a penny saved is a penny earned. That fits best with B Book Forex Brokers. To run an A Book, you need to avail services of Liquidity Provider, subscribe to Bridge etc.

All these involve cost in terms of one time set up fee, deposits and recurring fee based on volume. It’s like sharing the profits with others. It does make sense when you have clear sight of operation expenses are well funded.

But when you are running low on budget and want to get cash positive as soon as possible, you need to be smart with the upfront and recurring expenses. By running B-Book, Forex Brokers can save good amount of cost.

How B Book can kill a Forex Broker?

We have seen many Forex Brokers going belly-up because they were careless. B-Book could be double edged sword.

Let me explain how! While over 95% traders lose money, they don’t lose every time they trade. They may make money in some trades and lose on many. There are profitable traders as well, who happen to be pro-traders. They trade big so their profits/losses could be big too. A pro-trader can steal your profits that you made out of several losers.

Here is the list of 5 Pro Tips for a Forex Broker to ensure the profitability while running B-Book:

  1. Carefully asses your traders trade and categorize them into Winners & Losers
  2. Take opposite side of trade against loser Traders and make the money when they lose
  3. Hedge the positions whenever you fill orders against a winner trader. Don’t rely on luck. Hedge the position as soon as you take the position against a profitable trader.
  4. Send the orders of losing traders to B Book/ Dealing Desk and winning traders to A Book or Liquidity Provider
  5. Keep reviewing the list of profitable and loss making traders and see when and where they go right or wrong. This is will help you to grooming your risk management team at Dealing Desk.

NO DEALING DESK

This, as the names suggests is method wherein Orders of Traders are not processed through a Dealing Desk and directly sent to external network for settlement. The core idea of No Dealing Desk is same as to provide best possible quotes at best possible cost. No Dealing Desk Order Matching Process has further sub divisions:

ECN (Electronic Communication Network)

As the name suggests, ECN is electronic network all the participants of Forex Market like Reserve or Federal Banks, Prime Brokers, Banks, Hedge Funds, Mutual Funds, Corporations, Forex Brokerages and traders wherein orders from different participants are pooled together and matched with best possible counter party.

ECN is digital network that keeps on pooling orders and broadcasting to everyone connected with it. Everyone in network can see the Buyer & Sellers available at different price along with their quantities.

This makes life easier for traders to see and envisage where can they enter and exit a trade with higher accuracy and no or low slippage. They are sure that there won’t be any dearth of liquidity whenever they intend to take trade.

ENC Type Forex Brokers are most famous and considered to be one of the best Order matching arrangement for Forex Traders because its Organic & Natural in order. Different participants trade in open market which is the most liquid market when it comes to trading.

Key features of an ECN (Electronic Communication Network)

  • ECN provides the most trusted, transparent liquidity source for forex markets
  • By nature of order pooling and dissemination, most of these are Limit Orders.
  • ECN is a network which essentially means there are no intermediaries. All the participants are directly connected.
  • Since it’s a network of different participants, it offers great level of privacy as well as security. No one can target you by identifying your trading pattern and do the mischief.
  • Most of ECNs levy Access Charges to connect with the network first and then the Commissions on trades. It makes use of ECN for order processing costlier than the B Book where orders are matched at Dealing Desk of Forex Broker.
  • Since ECN is network of worldwide traders and brokers, one can trade even during after-hours.

STP (Straight Through Processing)

STP is another method of No Dealing Desk Order Matching. It’s a network of several liquidity providers and other large institutions that take the other side of trades. Liquidity Providers have their own dedicated team to manage the risks by hedging the positions against loss making trades.

Key features of an STP (Straight Through Processing)

  • Higher liquidity makes it easier to enter and exit a trade
  • Spreads are very low and affordable
  • High Trustworthiness among forex traders because Broker doesn’t take other side of trade. This means brokers is neutral to profits and loss made by the trader which is not the case with B Book brokers.
  • No or very low slippage
  • Negligible or no incidents of price re-quotes which is plenty in Dealing Desk Order Matching

HYBRID

It’s up-to the forex brokers to choose what type of forex broker they want to be and whether to go with A-Book/ Dealing Desk or B-Book/ No Dealing Desk models but the Forex Traders are ultimately going to choose the model they want and drop the one they don’t like.

Both A Book & B Book Order Matching mechanisms have their advantages and disadvantages for forex brokers and traders. On one hand brokers are trying to increase their revenue and on the other hand forex traders want the highest liquidity at lowest cost or free of charge. This conflict of interest brings whole forex brokers and trader’s relationship at loggerheads; and both parties suffer due to this trust deficit.

There is a mid-way to handle this dilemma; pick the Hybrid or C-Book model! It mostly works in favor of Forex Broker. They send loss making traders’ orders to B-Book or Dealing Desk and route the orders of profit making traders’ to A-Book. This way they can offset the risk and losses associated with it.

C-Book is considered to be the most optimized Order Matching process for Forex Brokers who have proper understanding of brokerage business and risk management. All they need to do is to have a clear classification of their clients into Profit Making Traders and Loss Making Traders. This helps in managing the order matching process and make the most of brokerage business.

While A-Book saves on the additional cost, it generates additional profits due to losses made by clients. B-Book or Hybrid model comes with additional cost but helps them provide the liquidity and avoid the losses.

Liquidity Providers & ECNs are not stupid and understand the risk but they still do it for following reasons:

  • They have qualified and experienced risk management team who monitors the trade. Wherever they feel they are going to make losses by taking opposite side of trade, they hedge the positions somewhere else to off-set loss.
  • They want commitment on a minimum volume that you would send to them on specified period
  • They charge Deposit Fee & Commissions
  • They don’t allow smaller quantities. Only the large volume of trades can be sent to them
  • They despise scalpers

CONCLUSION

Hope this article brought greater clarity about the Forex Brokers Types like A Book, B Book & C Book order matching methods which are also known as No Dealing Desk, Dealing Desk & Hybrid respectively.

We do understand that as a start up forex broker, you want a clear black and white answer to which method to chose for your business. To make your life easier, here is what we suggest:

  • Start with A-Book! Subscribe to some reliable and trustworthy Liquidity Providers. ECN may not be suitable for you, if you have budget constraints and not sure about how much volume your forex brokerage is going to generate.
  • Promote yourself as A Book Type Forex Broker which will get you eyeballs and quick sign ups
  • Let the traders make trades for couple of weeks. Analyse the trading history of all the traders and categorize them into Profit Making Traders, Loss Making Traders & Not Sure. Don’t worry about the manual work. There are software and tools for that. We will discuss them in Forex Brokers Software & Tools segment.
  • When the categorization is done, start Order Matching in following fashion:
    • Loss Making Traders : Send their orders to B-Book and take opposite side of trade
    • Profit Making Traders : Send their orders to A-Book and let them take opposite side of trade
    • Not Sure : When in doubt about a traders whether he is making profit or loss, don’t send them to B-Book rather send them to A-Book/Non Dealing Desk
    • Last and most important step is to keep reviewing the categories and list of traders in each of the bucket. For a sizable number of client base, you would always have some traders moving from one basket to another. Keep updating who is managed by Dealing Desk and who goes to no Dealing Desk. This will keep you profitable over the long haul.

Hope you are all set to move to next level of understanding the different types of forex brokers and about How to Start a Forex Brokerage Business and Run it Profitably!

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