Not all Forex brokers are the same. There are various models of Forex broker, defined by their relationship to the larger Forex market and the InterBank system of liquidity providers.
There are two camps that Forex brokers tend to fall in to – direct market access or market maker. While it may sound a little technical and unimportant to the layman, which camp a broker is in can make a big difference to how they handle your orders and ultimately to your trading results. So understanding this is important if you want to maximize your trading returns.
Let’s take a look at the two types of broker and what they mean for you.
What is Direct Market Access?
Direct Market Access, or DMA, is a type of execution that Forex brokers offer when they have direct access to the InterBank system of banks and financial institutions that make up the Forex market. Brokers who have this direct access are typically known as ECNs or STPs.
ECN stands for electronic communications networks and denotes the fact that these brokers have direct access to other participants in the broader Forex market.
As a result of this, these brokers tend to have much tighter spreads than brokers with other brokerage models. ECN brokers have no dealing desk and pass your orders directly to liquidity providers. For this reason, ECNs typically have the best execution among Forex brokers. Since ECNs forward your trades directly through to liquidity providers, there is no conflict of interest.
STPs are a very similar concept to ECNs. STP stands for Straight-Through Processing and identifies a broker who has no dealing desk and sends orders directly to the InterBank system. However, STPs are connected to liquidity providers through a bridge, which allows brokers to connect and fill the trades. For this reason, STPs are not completely devoid of conflict of interests as ECNs are.
What are Market Makers and How Do They Differ?
Another type of Forex broker is called the market maker. These brokers take on all client orders and either match them with other clients or take on the role of counterparty themselves – or in other words, take on the trade themselves, knowing that most of their clients will lose money overall. In this sense they act more like a bookmaker in sports betting, taking on their client’s bets.
Since liquidity varies throughout the day, the market maker takes the role of counterparty quite a bit throughout the day in order to keep the orders flowing. This means that a large number of the trades that are made through market makers are made with the broker themselves, creating a significant conflict of interest.
Client losses are generally the number one source of profit for market makers, in contrast to ECNs and STPs, who earn their money through the spread, fees or commissions. Many market makers have been accused of:
- Price manipulation;
- Stop-hunting – the practice of manipulating the price of a currency pair just long enough so that a client’s stop-loss orders will be triggered;
- Slippage – where the price you request on an order is different from that you actually get.
Since market makers typically have a dealing desk and intervene in every trade that is made, the execution is not as good as with ECNs and STPs, who simply forward your trade to the larger Forex market. Due to the poor execution, high-frequency trading strategies like scalping will typically not be effective due to the relatively poor execution. In fact, many market makers resent scalping and ban it outright.
All of this adds up to making those brokers who are market makers only and don’t offer direct market access somewhat more limited and risky than those that do. Would you really want your broker to be trading against you? And would you trust them if they were?
Brokers With Direct Market Access
So you may prefer a broker with direct market access which would make sense given that they don’t take positions against you in the market. That reduces the chances they will manipulate prices to take out your stop losses, have lots of slippage and generally have an interest in you making losses.
However, what kind of access they provide is not something most brokers advertise, particularly if they are a market maker so it can be difficult to figure out which camp brokers fall into.
There are some who are supposedly known to have direct market access though and these include:-
- IG Index
- Saxo Capital
- Interactive Brokers (IB)
Brokers Offering ECN Accounts
Then there are brokers who whilst they may have some market maker facilities as standard, also offer ECN accounts to their clients. Often this is for a higher minimum deposit than standard accounts though, but at least means the broker should not have a conflict of interest against you if you are using an ECN account.
Brokers known to offer ECN accounts include:
- Octa FX
- FP Markets
- Admiral Markets
- Hot Forex
This is not an exhaustive list and there may be other brokers out there offering ECN accounts, but these are the main ones we are aware of at the moment.
Why Would You Want to Use a Market Maker?
Some clients use market makers for various reasons, even though they acknowledge the general disadvantages of doing so. Some clients simply prefer the platform that a market maker uses.
Since market makers profit from client losses, there is a strong impulse with market makers to attract new Forex traders. As part of the strategy to attract inexperienced Forex traders, market makers have developed some of the most user-friendly trading platforms in existence and some of them have attractive new account offers like deposit bonuses of hundreds of even thousands of dollars.
These easy-to-use platforms and new account offers bring new traders into the world of Forex. Some of these traders have their accounts wiped out and then give up altogether. But some go on to learn more about Forex and move on to brokers where they have a greater chance of success.
Market makers, since they are not connected directly to the larger Forex market, may offer tighter spreads than the actual Forex market in certain cases. This can be to a trader’s advantage if the spreads quoted on the market maker are tighter than those in the wider Forex market.
When choosing a broker, you will normally want one with quicker execution and a low degree of conflict of interest. ECNs and DMA offer the best execution and a complete lack of conflict of interest since they simply forward your trade on to liquidity providers.
STPs are a close second. But they are a hybrid between ECNs and market makers. While they offer trades without intervention, your trade can also be filled by brokers who could present a conflict of interest.
Market makers are a completely different story from brokers with direct market access. They operate a more or less closed market where they either match your order with another client or take the opposite side of the transaction themselves.
Contrary to the disadvantages of using a market maker, some prefer them because they offer more user-friendly trading platforms and the isolation from the larger Forex market can be advantageous when they have not adjusted their spreads.
The contents of this website are intended for educational and information purposes only and do not constitute any form of advice or recommendation and are not intended to be relied upon by you in making (or refraining to make) any specific investment or other decisions. Appropriate expert independent advice should be obtained before making any such decision. We cannot and do not offer individual investment advice.