Forex Brokers: How They Work
Most forex brokers offering accounts to retail traders operate in one of two ways. It is unlikely that you will be signing up with a broker who has their own dealing desk. More likely, you will be looking at either an ECN broker or a market maker.
1. ECN Forex Brokers
These companies use the Electronic Communication Network, a global online marketplace that caters for many different types of trader from retail to the big banks and market makers. The spread on the ECN is small, sometimes almost non existent, so brokers using this network will usually either add a couple of pips to the real spread or charge commission or fees per deal. You can often get better prices from an ECN broker but take a close look at their fee structure and consider what it would mean for you on a typical deal.
ECN brokers are often better for scalpers and may even welcome them because they are dealing directly with a big market. Slippage is not so much of an issue, either for scalping or at times of forex news reports. They are also usually well regulated.
On the downside, the variable spread can mean more uncertainty when setting stop losses and limit orders. ECN brokers also tend to offer fewer charts and may have a less user friendly trading platform because they are not specifically aiming to attract beginners. They tend to assume that you know what you are doing and have a paid subscription to do your technical analysis elsewhere.
2. Forex Market Makers
Market makers usually offer you their own prices, based on the price that they expect to get on the ECN. When you open a deal they need to match it in the ECN to cover their risk. Clearly here there is room for the price to change in the moment between you clicking the button and the deal going on to the ECN. This is slippage. It can mean that you do not get the price that you expect, which can be a problem, especially for scalpers who are usually looking for very small profits from each trade. For this reason scalpers and market makers are not a good mix and could be unwelcome.
On the positive side, market makers can be a good choice for a beginner. They will usually provide good technical analysis, news alerts, a user friendly platform and a demo account. They will almost always offer a mini forex trading account so that you can start trading with a few hundred dollars or less. This is a very important factor for many new traders choosing forex brokers.