Automatic vs Manual Intervention
Establishing whether your broker is an A Book, B Book or Hybrid broker is the first step. This is where you are establishing who is the Market Maker in your trades. Once you know whether your broker is also your market maker, you then need to establish how they process those trades. This is essentially working out if your trade processing is automated or if there is manual intervention.
What is a Dealing Desk – DD?
If you have a B Book broker or a Hybrid broker that runs both an A Book and a B Book then you are looking at a broker with a Dealing Desk (DD).
A Dealing Desk broker is a broker that reserves the right to have a human-being look at your trade. They may reject it or offer a different price if desired. It means that the process is not fully automated. This is the model used by B Book brokers and Hybrid brokers that hold some, or all, of your trades on their own book rather than pass them into the market. It means that the broker can process your order in different ways depending on your profile as a trader. The Dealing Desk is the part of the business that handles this.
It can seem like a disadvantage to using a broker with a Dealing Desk. If you are a large or profitable trader you may be more likely to have your trades scrutinized by a B Book Broker. If this is the case then your broker stands to lose when you win; you may wish to move. As mentioned in Part 1 of this series, there are a number of reasons people choose to use B Book / DD brokers, particularly when Spread Betting. You can often access better proprietary platforms, zero commission trades and larger, well-capitalized brokers.
What is No Dealing Desk – NDD?
For the same reasons that some traders like to avoid B Book brokers, they may also say that they are looking for a No Dealing Desk (NDD) broker. NDD is a catch-all term for the different types of the broker that work on a purely automated trade-processing basis.
No employee of your NDD broker will see your trade or have the ability to change the way that it is processed. If you have a No Dealing Desk broker you know that all of your trades will be treated the same way regardless of your trader profile. There will be no dealer interference.
Of course, your trades still have to go somewhere. Your next task is to establish where your NDD broker sends your orders. After all, someone has to be on the other end of your trades!
Within the NDD world, we have a number of specific types of a broker. These are named after their chosen trade processing and trade matching system.
What is Straight Through Processing – STP?
If your broker engages in Straight Through Processing this means that when you place a trade then the entire lifecycle of that trade, or at least the portion that your broker is involved in, is conducted automatically without human intervention. This is the basic level NDD broker model.
If your broker uses an STP model then you can rest assured that they will not do anything to your trade other than executing it in the wider marketplace. They will do this as quickly and efficiently as their automated systems will allow.
However, a regular STP broker could be said to still be taking the other side of your trade. That is, they act as your counterparty but then automatically put the exact same trade into the wider marketplace by sending it to their Liquidity Providers (LP) or ECN. In practice, this means that they don’t trade against you in any way.
They may use one or several Liquidity Providers, who are usually banks or other brokers. The Liquidity Providers will compete to offer the best price to the broker (the lowest spread). Your STP broker may then pass on this exact spread to you. This means that the spread will be variable. Alternatively, they may add a little extra for their own profit, meaning the spread will be fixed or variable.
The Liquidity Provider and your Broker both need to make money, so you can expect to see a slightly marked up spread, a commission charged, or possibly both.
Your STP broker is your initial counterparty, but they send the equivalent trade to their Liquidity Provider automatically. They do not profit when you lose and your true counterparty is the LP. This is what sets them apart from a Dealing Desk or B Book broker who do not routinely pass through all trades.
Your trades should be anonymous. Because your broker passes ALL of their trades to their LPs this means that you will never be re-quoted or rejected as part of the ‘toxic flow’ of Hybrid brokers that we covered in Part One.
However, you may experience some rejected orders or slippage problems despite the fact that your STP broker is not taking the other side of your trades. This is because the Liquidity Provider(s) that your broker is using operate in largely the same way as a B Book broker – they win when your broker loses!
The LPs are acting as the Market Maker and ultimately taking the other side of your trade. If they don’t like what they see, or markets are moving too fast, then in some cases you can experience problems with your broker having their orders rejected or slipped.
What is Direct Market Access DMA?
If your broker offers Direct Market Access (DMA) then they are a No Dealing Desk broker with a Straight Through Processing model. The key difference between a regular STP broker and a DMA STP broker is that with DMA your trade never hits your broker’s book. It is placed directly with the Liquidity Provider or other counterparties.
STP DMA brokers will use more than one Liquidity Provider to get the best price for their traders. The LP that wins your order takes the other side of the trade, but you can be reassured that it is not your broker themselves that are taking the other side.
Because your trades are placed directly into the market with competition between Liquidity Providers, you should not experience rejection, slippage or re-quotes for your orders. You are getting the true market execution in a competitive environment. You may not receive the exact price that you clicked but this will only be because of the time it takes for the transaction to get to the LP. Sometimes price moves with extreme speed and you will get filled at a different price to the one you clicked.
Again, as with regular STP models, your broker also needs to make money and it is likely that you will be paying a commission as well as the spread.
What is an Electronic Communications Network – ECN?
A broker that uses an Electronic Communications Network (ECN) is taking advantage of the latest technology. They offer a trade matching system that does not rely only on large institutional players to provide liquidity. This is still an NDD, STP model with Direct Market Access, but it is adding an extra layer of trade matching finesse.
The ECN provides a marketplace that can include the traditional Liquidity Providers (banks, brokers, etc) but also includes other traders (hedge funds, retail traders, etc). All of these participants are sending their orders into the marketplace. They will have their trade matched by a trader or participant on the other side. Both will receive the best available price being offered by another participant at that time.
In reality, it may be that your trade is broken into smaller pieces or that your trade matches only part of a larger trade on the other side. All of this is taken care of automatically and has no impact on your trading.
This is the closest that a retail trader can get to a true marketplace. You have a variety of participants to trade against, none of whom have any part to play in the actual routing and processing of their orders.
The drawback is that you will pay spread plus commission. It can be that you end up paying slightly more than you would for just regular STP or DMA trading. As it is expensive to provide this service you may also need a slightly larger deposit than other brokers.
As with all NDD brokers, it may also be that your broker is vastly less profitable. It pays for expensive technology and doesn’t profit when you lose. This may mean that they have fewer bells and whistles on their trading platform or perhaps just offer MT4.