So you hate market maker brokers? There are common misconceptions about them spread around in the industry. The explanation below may change your mind about them.
Market maker brokers are often vilified by traders. Stop loss hunters, price manipulators, money stealers; all kinds of negative stigma have been attributed to market maker brokers. However, many perceptions circulated among traders about market maker brokers are inaccurate or even downright misleading. In this article, we will address three important facts about market maker brokers. But before that, let's discuss the different types of brokers.
Types of Brokers
Forex brokers apply different models to their business. Depending on how they connect traders to liquidity providers, brokers can be either dealing desk or non-dealing desk.
Dealing Desk Brokers
Dealing desk brokers are brokers that operate their own dealing desk for executing orders from traders and make the market for the traders. These brokers act as the counterparties to traders. If you are the buyer, then the broker is the seller and if you are the seller, then the broker is the buyer. In other words, they take the opposite position of your trade. This is how a conflict of interest between traders and brokers could arise.
Dealing Desk brokers typically present attractive offers to their clients, such as leverage as high as 1000:1, no interests, low spreads (generally fixed spread), various bonuses, and ease of deposit and withdrawal via third parties.
However, you should be aware that Dealing Desk brokers mark up the price quotes that they send to traders. The prices they show on the platform are not the same as the quotes from the interbank system, and it is very difficult for traders to identify the real quotes. In addition, it is not a rare occurrence for these brokers to trade against the traders, especially if the brokers lack reputable regulations.
See Also: The Hidden Truth of Forex Broker License
Non-Dealing Desk Brokers
Non-Dealing Desk brokers do not operate a dealing desk and act merely as intermediaries between traders and the interbank market. These brokers do not offer their clients fixed spreads as they have to follow the market condition. The spreads are also generally higher than those of market maker brokers. In addition, they may also charge commissions.
In most cases, Non-Dealing Desk brokers do not trade against their clients as they are not the trade counterparties. Non-Dealing Desk brokers generally can be classified as the following.
- STP Brokers
Straight Through Processing (STP) brokers route orders from traders to their liquidity providers that have access to the interbank market. These brokers usually have several banks or financial institutions as their liquidity providers; each offers different bid/ask price quotes. If you make an order to an STP broker that has three liquidity providers with different price quotes, the broker will sort the best quote for you and offer this price through their platform. STP brokers make money from the spreads on every transaction that traders make plus the price quoted by their liquidity providers. This is why STP brokers typically have floating spreads.
- ECN Brokers
Electronic Communication Network (ECN) brokers enable their clients to directly interact with the ECN market participants that include banks, hedge funds, brokers, and other traders. ECN brokers also allow you to observe the depth of market or even the orders of other participants. Such system typically leads ECN brokers to require large funds for the account deposit and charge high commissions.
See Also: What are the Best ECN Brokers?
Hybrid brokers are the combination of ECN/STP and Market Maker/Dealing Desk brokers. Usually, these brokers offer a variety of trading account types with specific rules on how to execute orders. For account types with small lot sizes (micro, mini, etc.), the brokers will act as the dealing desks. However, if the orders are of large positions, brokers will treat these with the ECN or STP model. It is not easy to identify whether a broker is hybrid or not; therefore, you should make your own research on the broker.
Now that we've learned the types of brokers, let's debunk the three most common misconceptions about market maker brokers.
1. Dealing Desk Brokers = Market Makers?
The term dealing desk brokers is often used interchangeably with market makers. However, this is not entirely true. Market makers are the parties that provide liquidity and quote both the buy and sell rates. They can be individuals, brokers, banks, hedge funds, and other financial firms. Large banks in particular are the master of market makers.
See Also: 5 Major Banks Offering FX Retail Trading
One simple example of market-making practice is a foreign exchange transaction in a local bank. This is very similar to the business activity of market makers in forex trading. Let's see the illustration below.
Dolan is in need of USD currency for a trip to the USA. He carries the local currency EUR to Bank Z to be exchanged with USD. In this case, Dolan wants to buy USD and Bank Z makes the market by selling USD and buying EUR. One month later, Dolan returns home and wants to exchange his remaining USD with EUR. He visits Bank Z again, and this time Bank Z makes the market by buying USD and selling EUR. Here, Bank Z generates profits from the differences between the sell rate and buy rate.
A similar model is practiced by parties better known as liquidity providers and prime brokers in the world of forex trading. Obviously, the scale of their business is far more massive than that of retail brokers. In short, market makers encompass various market participants, and the dealing desk brokers are only one of them.
2. Market Maker Brokers are Definitely Frauds?
If market maker brokers, unregulated brokers, and offshore brokers are prone to committing frauds, why do many traders still sign up with them? This is where the next misunderstanding about market maker brokers arises. The truth is, forex traders choose a broker based on needs, not prestige.
If a trader prioritizes the security of their funds, they will register to a highly regulated forex broker with several licenses from top regulatory bodies. If a trader needs precise executions and low spreads, they will register to an ECN broker. However, what if a trader barely has enough funds? They will look for a broker that offers high leverage and low deposit. Or perhaps what a trader seeks is big bonuses, rebates, or free money as trading funds. For these types of traders, market makers brokers, unregulated brokers, and offshore brokers are their best choices.
Do you know that the famous OANDA which is well-known for its high credibility in the USA, UK, and Canada also uses the market maker model? Yes, as a pioneer of nano lot size in forex trading, they proudly announce themselves as a market maker. It is something that cannot be offered by ECN brokers. However, we cannot compare this USA-licensed broker with fraud brokers such as MFX Broker, even though both execute trading orders as the counterparty.
Market maker brokers are often portrayed in negative lights as the brokers that purposefully gain profits from traders' losses. Nonetheless, many retail forex brokers that act as market makers are licensed by the NFA/CTFC of USA, FCA of UK, and other reputable regulatory bodies, thus they must obey the rules and laws of market makers as stipulated by the regulators. Market maker brokers with offshore licenses or no regulations, on the other hand, are more susceptible to commit unscrupulous business activities. Some could be trustworthy, some are questionable.
See Also: 5 True Stories of Forex Broker Scams
3. Market Maker Brokers are Worse than ECN Brokers?
From our discussion above, you can understand that not all market maker brokers are wicked. We can immediately determine the quality of forex brokers with their regulatory status. The more reputable the regulators, the better the brokers' credibility. However, the classification of brokers as market makers, STP, or ECN cannot be used as the standard to measure their quality.
The majority of forex brokers are actually hybrids that provide market maker, STP, and ECN conditions all at once. Even if brokers implement the STP/ECN model, their liquidity providers are still market makers. Thus, it is not wrong to say that all forex brokers are basically "market makers". Therefore, we cannot determine a broker's quality based on this label.
If you do not want to be a victim of scams, avoid unregulated brokers. All unregulated brokers are almost certainly scammers. Sooner or later, traders who become their clients will lose money. If you actually manage to gain profits with them, leave immediately and withdraw all your money before the brokers close their operation.
How about offshore brokers? Roughly speaking, we can estimate that 50% of them are trustworthy, but the other 50% are not different from unregulated brokers. On the other side, regulated brokers are more credible, but some of them do exploit loopholes in regulation.
Brokers can and will commit fraudulent activities regardless of what model they operate with. This phenomenon is not exclusive to market model brokers alone. For example, a broker may present itself as a Non-Dealing Desk. As it turns out, the broker and its liquidity provider are actually owned by the same person. This scheme enables said broker to actively trade against you without you realizing it.
In short, Market Makers can be concluded in this infographic.
Judging brokers' quality solely based on their type is not a sensible thing to do. So no matter what type of broker you're about to register with, it's highly recommended to research its track record and check the reviews first.