What is a forex broker?

A forex broker acts as the intermediary between buyers and sellers in the Foreign exchange market. If you wish to trade Forex (i.e. buy and sell two different currencies), a Forex broker will typically offer you the best price available from their pool of liquidity providers on the interbank market. This interbank market refers to the network of banks and other liquidity providers that trade with each other.

Without a Forex broker acting as the intermediary, you and other retail traders will not be able to (or at least find it difficult) access the interbank market.

When choosing a forex broker, it's crucial to consider various factors such as regulation, trading platforms, execution speed, and customer support. As a trader in Australia, finding the best Australian forex broker is essential to ensure a safe and efficient trading experience. The best Australian forex brokers are regulated by the Australian Securities and Investments Commission (ASIC), offer competitive spreads, and provide a range of educational resources to support their clients.

The forex market has undergone significant changes since the 1970s, when the United States abandoned the Bretton Woods Agreement, which used gold as the store of value. This shift gave rise to a new global financial market dominated by forex trading, allowing for the exchange of one currency for another. However, the forex market was initially only accessible to institutional traders, such as banks and large corporations, who could afford the high minimum trade sizes and commissions.

As technology advanced and the internet became more widespread in the late 1990s and early 2000s, a new type of forex broker emerged: the online retail broker. These brokers leveraged the power of the internet to provide individual traders with access to the forex market. By offering smaller trade sizes, lower commissions, and user-friendly trading platforms, online retail brokers democratised forex trading and opened up the market to a wider audience.

Today, a wide variety of forex brokers cater to the needs of both retail and institutional traders, offering diverse trading instruments, competitive pricing, and advanced trading tools.

The term forex broker might occur to you as being onerous, but in reality, not all forex brokers are equal, and there are slight differences between them. Understandably, trading in the forex market can be a thrilling experience for you. However, it's essential you know the different types of forex brokers, not for any reason other than the fact that you need to have the right broker by your side to make enormous success and not fall into the category of those who equate the forex market as a dreadful endeavor. There are two main categories of forex brokers - No dealing desk and dealing desk.

1. No dealing desk forex brokers

NDD forex brokers do not create their own market. Instead, they rely on prices set by banks or liquidity providers. You access trades from third-party sources, and the broker takes a commission or widens the bid-ask spread to profit from the trade. One advantage of using an NDD forex broker is that you are exposed to variable spreads and enjoy increased transparency while trading forex. You can see real-time market movements and implement various trading strategies to maximise your profits.

NDD forex brokers can be further categorised into two types: straight through processing (STP) and electronic communication network (ECN) brokers. STP brokers automatically route your orders to liquidity providers without manual intervention, ensuring faster execution and reduced risk of human error. ECN brokers, on the other hand, provide you with direct access to the interbank market, allowing you to see the depth of market and execute trades at the best available prices.

2. Dealing desk forex broker

Also known as market makers, DD forex brokers have dedicated dealing desks and do not rely on external liquidity sources. They can set bid/ask prices based on their own research and quickly aggregate and place your orders with liquidity providers. The advantage of DD forex brokers is their extensive control over the entire transaction process. Since they accept the risk of holding specific positions for particular currency pair orders, they can execute your orders within seconds.

DD forex brokers often offer you fixed spreads, which can be beneficial if you prefer predictability in your trading costs. However, fixed spreads may be wider than variable spreads offered by NDD brokers, particularly during periods of high market volatility. Additionally, there may be potential conflicts of interest, as DD brokers profit from client losses.

3. Electronic communication network (ECN) forex brokers

ECN forex brokers offer you anonymity and do not have dealing desks. They use electronic software trading systems to provide you with direct market access, acting as a middleman between you and tier 1 banks or liquidity providers. ECN brokers use cutting-edge technology like the Financial Information Exchange (FIX) protocol to facilitate your trades. While working with an ECN forex broker may be technical for some traders, it is beneficial for you if you are a high-volume trader with a large account.

Forex is a 24-hour, five-day-a-week financial market. However, to participate in this market, you need the service of a forex broker to provide you with the essential tools and functionalities to execute your trades. The role of forex brokers is quite extensive and covers all your forex trading needs, ranging from market access to liquidity provision, risk management, market information, and research.

1. Trade facilitation and order execution

Forex brokers help facilitate your buying and selling of currency pairs in the 24-hour, five-day-a-week forex market. They ensure efficient processing of your various order types, such as market orders and pending orders, when all appropriate conditions are met.

2. Risk and margin management

Risk management is crucial in forex trading, and brokers play a vital role in educating you about the inherent risks and providing tools like stop-loss orders to minimise your losses. Brokers also handle margin management, closing your positions when you lack sufficient capital to serve as collateral for your open positions. This prevents losses from significantly impacting your capital.

3. Pricing and liquidity

The forex market is the most liquid market in the world, with an estimated daily turnover of around $6.5 trillion. Forex brokers ensure that you can access this liquidity and execute your orders seamlessly without slippage.

4. Market research and analysis

Forex brokers provide you with essential trading tools to help you conduct market research and analysis. These tools include charting tools, technical indicators, and real-time price data movement dashboards.

5. Customer support and education

Reputable forex brokers offer you excellent customer support, assisting you with account-related queries, technical issues, and general trading guidance. Many brokers also provide educational resources, such as webinars, tutorials, and market analysis, to help you improve your skills and stay informed about market trends.

One of the banes of most traders is the arbitrary selection of forex brokers without considering every possible factor. This is a crucial step that impacts your trading experience, fund security, time of execution, and others. The following are the factors you should consider when choosing a forex broker.

1. Regulatory compliance

Regulatory compliance is crucial to protect your funds and safeguard your portfolio. Hence, you should ensure that your chosen forex broker is in compliance with the regulations of reputable regulatory bodies such as the Australian Securities and Investment Commission (ASIC), U.S. Commodity Futures Trading Commission (CFTC), and U.K. Financial Conduct Authority (FCA).

2. Ease of navigating trading platform

Every broker has a trading platform that you will use to enter, oversee, and exit your trading positions. The best Forex trading platforms for Australian traders are intuitive and have a simplified user interface and experience. Also, you should look for a platform that is stable and has all the requisite tools and other features that align with your trading style.

3. Speed of order execution

Go through the broker's documentation to analyse their execution policies. This is an important step you should take to ascertain the speed and accuracy of your trade execution. The key variables you should look out for are the broker's policy on requotes, which is the efficiency at which you can request new order execution at a different price. Another thing is to check for the broker's slippage frequency to determine the rate at which your orders execute at the prices you set.

4. Trading costs and fees

There is no unified trading cost and fee structure when it comes to forex brokers. Different brokers have different fee structures, so it is advisable for you to compare the spread on different currencies. Also, you should look at each broker's commissions and swap rates, especially those in the NDD and ECN categories.

5. Educational resources

You should prioritise brokers that provide educational resources, documentation, and webinars. Educational materials are essential for refining and updating your trading skills, whether you are a novice or an experienced trader.

Forex brokers employ several strategies to generate revenue, with the primary source being the spread between bid and ask prices. However, there are additional ways in which brokers profit from their services.

1. Spreads

The most common way forex brokers make money is through the spread, which is the difference between the bid (sell) and ask (buy) price of a currency pair. Brokers access lower spreads from their liquidity providers and add a mark-up before offering the quotes to you. The spread can be fixed or variable, depending on the broker and market conditions.

2. Commissions

Some brokers, particularly ECN and NDD brokers, charge you a commission per trade in addition to or instead of the spread. Commissions are usually a fixed percentage of the trade value or a flat fee per standard lot traded. You should calculate the total cost of trading, considering both the spread and commissions, to determine which pricing structure is most advantageous for your trading style.

3. Overnight swap rates

Forex brokers also earn money through overnight swap rates, also known as rollover fees or interest. When you hold a position open past the end of the trading day (typically 5pm EST), you are subject to a credit or debit based on the interest rate differential between the two currencies in the pair.

4. Account fees

Some brokers charge you various account fees, such as inactivity fees, monthly or quarterly maintenance fees, or deposit/withdrawal fees. It's essential for you to review a broker's fee schedule carefully to understand all potential costs associated with trading and account management.

5. Leverage and margin

Forex brokers offer you leverage, allowing you to control larger positions with a smaller capital outlay. Leverage is essentially a loan from the broker to you, and brokers make money by charging you interest on the borrowed funds (the margin).

6. Additional services

Some forex brokers offer you additional services, such as managed accounts or copy trading platforms, which can generate revenue through management fees or performance-based fees. Brokers may also earn money by offering you premium services, such as advanced charting tools, market analysis, or educational resources, for an additional fee.

Forex brokers are the key cog behind every trade execution. This is achieved by providing you access to leverage, essential charting tools, and, most importantly, the platform that allows you to participate in the forex market.

The complexities in the forex market require different varieties of needs and specialties. These complexities led to categorising forex brokers into three distinct types: non-dealing desks, dealing desks, and electronic communication systems. Each type has distinct functions that are centred around functionalities like trade and order execution, pricing and liquidity provision, educational resources, market research, and analysis.