Saturday, 19 July 2014

Types of Forex Brokers : DD - NDD - STP - ECN - Market maker - Bucket shop

Types of Forex Brokers

DD (Dealing Desk)

NDD (No Dealing Desk) 

STP (Straight-through processing)

ECN (Electronic communication network)   

Bucket shop


How do Forex brokers make their profits ?

Definition of 'Dealing Desk'
In forex markets, the location of a financial institution's forex dealers. Since the forex market is open 24 hours a day, 5 days a week, many institutions have dealing desks around the world. Dealing desks can also be found outside the forex markets, such as in banks and finance companies, to execute trades in securities.

DD - Dealing Desk - Forex brokers that operate through Dealing Desk (DD), typically offer fixed spreads and may elect to quote above or below actual market prices at any time. A dealing desk broker earns profit via spreads and by trading against its clients. A Dealing Desk Forex broker is called a Market Maker - they literally create a market for their clients: when traders want to sell, they buy from them, when traders want to buy, they sell to them, e.g. they will constantly take the other side of the trade and in this way "create the market". A trader doesn't see the actual market quotes, which Dealing Desk brokers (Market Makers) operate with their quotes where they need to in order to fill the client.

Definition of ' No Dealing Desk'
A way of forex trading that provides immediate access to the interbank market. The interbank market is where foreign currencies are traded. This is different than trading through the dealing desks that are found in many banks and financial institutions. By using a dealing desk, a forex broker who is registered as a Futures Commission Merchant (FCM) and Retail Foreign Exchange Dealer (RFED) can offset trades. If a no dealing desk system is used, positions are automatically offset and then transmitted directly to the interbank.

NDD - No Dealing Desk - NDD Forex brokers provide access to the interbank market without transfering orders through the dealing desk. With true NDD brokers there are no re-quotes on orders and no delay during order confirmation. Which means there are no restrictions trading in high volatility market especially during economic announcements.
NDDs can either charge a very small commission for trading or just put a markup by increasing the spread slightly.
No Dealing Desk brokers are either STP or ECN+STP.

STP - Straight Through Processing - Forex brokers that have an STP system route the orders of their clients directly to their liquidity providers - banks, which trade on the Interbank. STP brokers usually have many liquidity providers, with each provider quoting its own bid and ask price. There are STP brokers have just one liquidity provider, but rarely. The more there are banks and liquidity in the system, the better the fills for the clients.

The fact that traders have access to the true market and can execute trades immediately without broker intervention is what makes the platform STP.

ECN - Electronic Communications Network -True ECN brokers, on the other hand, allow the orders of their clients to interact with the orders of other participants in the ECN. ECN Forex broker provides a marketplace where all its participants (banks, market makers and retail traders) trade against each other by sending competing bids and offers into the system. Participants interact inside the system and get the best offers for their trades available at that time. All trading orders are matched between counter parties in real time. ECN brokers usually make their money by charging a commission on the traded volume.

Sometimes STP brokers are discussed as if they were ECN brokers. To be a true ECN, a broker must display the Depth of the Market (DOM) in a data window, let clients show their own order size in the system and allow other clients to hit those orders. With ECN broker traders can see where the liquidity is and execute trades.

Broker types comparison and revenues: fixed vs variable spreads vs commission
ECN Forex brokers always have variable spreads. Only ECN brokers charge commission for trading Forex. ECN brokers earn profit only through commission. They don't make money on bid/ask (spread) difference.

While an STP Forex broker makes money via spread (spread markups - Explanation in details below).

STP brokers offer options of both variable or fixed spreads. STP brokers route all trading orders to the liquidity providers - banks. These brokers, as mediators between their traders and banks, receive prices (spreads) filled by the banks on the Interbank market. Most banks, actually, offer fixed spreads.

For that reason, an STP broker has 2 choices:

1. Maintain fixed spreads for its clients.

2.  Float the spread starting at 0 and let the system choose the best bid and ask from the number of banks (the more the better) and in this way provide variable spreads.

How an STP broker makes money? STP brokers (as well as ECN) don't trade against their clients, therefore, they add own small markups to the spread quote. This is done by adding a pip (or half a pip, or any other amount) to the best bid and subtracting a pip at the best ask of its liquidity provider. All client orders are directly routed to the liquidity providers at original spread quoted by those providers while an STP broker earns its profit from own markups.

Market maker broker - a broker with a dealing desk makes money by earning the spread (bid/ask difference) and also when a client loses a trade. It's because market makers are trading against their clients by hedging - entering in an opposite trade.

ECN brokers are the purest class among all Forex dealers. They don't profit on spread difference. Their only profit derives from commission. ECN brokers want their traders to  consistently make profit in trading , otherwise there will be no commission to earn.

STP brokers earn profit on spreads, thus even though they are not dealing desk brokers and don't counter-trade client orders, they are still able to quote their own price - the spread markup - for routing trading orders to liquidity providers and providing their clients with advanced trading services, lower account deposits, faster execution and anonymous trading environment with no dealing desk. STP brokers want their clients to profit from trading as well, so that a broker can consistently earning on spreads.

Market makers earn profit on spreads and by trading against their clients. However, if a client becomes "too" profitable, it can directly "upset" the broker. It's the fact that their revenue also derives on clients' loosing trades. While this may be tolerated and professionally managed by a larger reputable market maker, with a smaller dealer such client will be soon asked to leave.

Benefits of trading with No Dealing Desk brokers
Among the most important factor why traders look for NDD brokers is transparency, better and faster fills and anonymity.

Transparency means that a trader enters a true market instead of the market being artificially created for him.

Better fills are a result of the direct and competitive market bids and offers.

Anonymity means that there is no Dealing Desk monitoring who has come to the market and is asking for an order to be filled, instead client orders are executed automatically, instantaneously through the market network and totally anonymously.

On the opposite side is a Dealing Desk broker, who is able to profile their clients. In the worst case scenario, such broker can divide clients into groups and put less successful ones on auto-execution and trade against them because on average they will lose, while clients that show signs of successful trading will be put on "slow-down" mode and can be provided with frequent re-quotes, slippage and/or slower execution especially during fast moving markets while a broker tries to offset own risks. The transparency of a Dealing Desk broker depends on the rules inside the company.

Forex Brokers aren't bad on general, whether a Dealing or Non-Dealing Desk, they aren't there to be against any particular trader. They look to make business, not just work for traders in terms of cooperation in the market environment. Many large Forex brokers who have lots of clients tend to try to help their clients become profitable as much as they can, but once a trading order is placed, its everyone for themselves.

Some visual example
Types of Forex Brokers
Source :
Types of Forex Brokers

Bucket Shop
known as "sucker lists". In the securities industry a "bucket shop" is a broker/dealer whose ethics are questionable. Bucket Shop refers to a scam popular in the 19th century whereby an establishment claims to have sold you shares but they don't actually purchase any of the investments they say you are investing in, rather they run like a bookie and your investments are basically wagers on the price changes in the market.
Some traders assume all market makers are bucket shops but this is not really true. They just have the potential to become bucket shop. What's the difference? Well, we have covered the subject of market maker brokers. They are basically the same. Only that bucket shop is more like house broker and they perform many tricks to make you lose. I will show some example later.

Forex bucket shops are brokerage firms that have “questionable” trading practices (e.g., unusually frequent price misquotes or re-qoutes, slippage only favorable to the broker, stop hunting, etc.).
And it’s precisely this greedy, money-oriented philosophy that drives the people operating bucket shops. The name comes from brokers back in the day who used to put their clients’ phone-in orders on slips  and then dropped them (the slips, not the clients) in a tiny bucket instead of actually executing them.

Without putting the orders out into the free market, the client is actually betting against the forex bucket shop operators who are also known as bucketeers.
These old school bucketeers do not usually disclose the real price of the asset that their client is trading, which means that they could tell the client that the price moved or didn’t move–whatever was in favor of the broker!
But thanks to the invention of the internet–and improving regulations and enforcement–newbies have less to worry about these days.  Unfortunately, bucket shops are still out there so beware!
To help you separate the good brokers from the bad ones, check out (Site-offline, #Google-is-your-friend ;)), where fellow forex traders were kind enough to post their feedback on brokers.
So, before you deposit your money with just anyone, make sure to do your due diligence and espionage so that you avoid fraudulent brokers and forex scams. Mind you, there are plenty out there and we’ll look more into that later on!

Common tricks that bucketshops use - 
- Price lag 
- Manipulating quote (including placing orders on non-existence price)
- Slippage 
- Constant requote
- Price spike
- Slow execution
- Stop hunting

 Here are some clue for you :-
EXAMPLE 1 - Price quote manipulation
This is the price on other brokers

This is the price on bucketshop broker. 2-3 pips difference is normal, but this broker had 15 pips diference from other brokers:-



There are more examples, want to see more? google it.


Other useful link :-
How the retail Forex works. Dealers vs. Clients

Risk Disclaimer
Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. Past performance is not indicative of future results. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts.

Related Keywords: Forex broker, FX broker, Currency trading, Dealing desk, No Deadling Desk,
Straight-through processing, Electronic communication network, Bucket shop


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