The job of forex brokers is to connect traders to the forex market by providing them with an avenue to trade currency pairs and other financial instruments. Most forex brokers offer trading of forex on a “spot” basis, as well as Contracts-for-Difference (CFDs) on commodities, indices and stocks.
In other words, the forex broker acts as a middleman or an intermediary between you the trader and major banks/liquidity providers that offer currencies for sale on the interbank forex market. The model of forex brokerage will determine if you can access the interbank market using your forex platform directly (ECN/STP brokerage models), or if you have to get orders fulfilled in-house by the broker (market maker).
TYPES OF FOREX BROKERS
Two categories of FX Brokers operate in the markets. They are:
- Market makers
- ECN/STP Brokers
There are many traders who cannot come up with the trading capital required to maintain the liquidity that supports the forex market. It is for these traders that market makers came into being. What market makers do is to acquire large positions from the interbank market, and hold these positions in a “bucket”. When their traders place orders on the trading platforms provided by the market maker, these orders do not go to the interbank market. Rather, they are matched against the positions held in the bucket of trades. So essentially, the market maker is the party that sells to buyers, and buys from sellers. In this manner, the market maker is acting as the opposing party to any trade placed by traders on the retail forex platform.
If the trader wins, the market maker loses. If the trader loses, the market maker keeps the profit. The criticism of this system is that it can create a conflict of interest, where the market maker acts as a player and umpire at the same time in the same game.
ECN brokers operate on the Straight Through Processing (STP) or direct market access (DMA) model. As the name implies, orders placed by traders are not fulfilled by the broker. Rather, the orders are channeled straight to the interbank market, where they are fulfilled by one out of several available liquidity providers. Brokers only make money from the spreads on trades as well as on commissions charged on the entry and exit sides of the trade. This avoids the conflict of interest scenario. Typically, only traders with large amount of capital can access ECN platforms.
How Forex Brokers Perform their Functions
Currencies are offered for trading by major banks. They are also known as liquidity providers. They operate at the level of the interbank market and trade currencies among themselves. Forex brokers usually gain access to lines of credit and market liquidity and are able to offer the pricing of these currencies to their clients for trading.
- If you only have small capital (typically less than $10,000), you will not have access to the interbank market. You will need to use a retail market maker, whose job is to resell positions that they have acquired from the interbank market to you. So you can only get your orders fulfilled in-house by the market maker. In this manner, the market maker gives you access to forex trading, which ordinarily you would not have access to.
- If you have large capital (typically from $20,000), then you can gain direct access to the interbank market. You will pay commissions as well as spread costs, but you get to trade with several liquidity providers, and can choose the one that will give you the best pricing. Since your broker only profits from you being in the market and trading for a long time, they provide you with plenty of support to assist you in trading, and will not engage in practices that will shortchange you.
Functions of a Forex Broker
What are the functions of a forex broker?
- They provide the trading platforms that give the trader access to the forex market.
- They route orders to the interbank market for execution (ECN brokers), or provide the execution of traders’ orders themselves (market makers).
- Forex brokers provide a loan to traders to enable them trade larger positions with their capital. This “loan” is known as Leverage. The forex market only makes fractional moves at a time, so a lot of money is required to setup trades in the forex market. Most traders cannot come up with the full amount required to do this, so the brokers provide the leverage in various degrees to enable traders hold large positions.
- Forex brokers provide liquidity in the forex market.
- Forex brokers hold traders’ funds in trust as they engage the forex market.
How Can You Access the Forex Market Using Your Broker?
There are steps to follow when you want to gain access to the forex market using your broker.
- You must open a forex trading account
The broker is by law, mandated to collect certain data from you as well as documents to prove your identity and place of residence. The account opening process will also feature sections where a test of your investment knowledge is applied. Your data is stored in secure servers maintained by the broker.
- Depositing Funds
The forex broker holds your money in trust as you trade the market. The balance on your account is displayed on your trading platform. The forex broker is responsible for clearing and settlement of your trades and ensuring that the account balance data displayed on the platform is accurate. The broker will provide several means of payment to enable you deposit trading funds.
- Trading Data
The broker will provide you with a trading platform which features all kinds of data (news feeds, price data for various currency pairs, etc). The platform also provides you with an avenue to perform analysis using various tools and indicators, as well as the act of trading. You will be given access to buttons and functions that can be used to initiate trades as well as exit trades.
When you want to withdraw money, the broker will deduct this from the segregated account where your funds are held, and send the money back to you using your chosen means of withdrawal. This is done using the banking details you supplied when opening the account.
Brokers understand the need for sound trader education to help their clients trade better, and remain longer on the platforms to generate money through spreads. Therefore, many brokers are now investing in quality forex education through provision of videos, “how-to” training’s, etc.
This article provide by B2Broker.