Dealing desk vs non-dealing desk brokers:
What's the difference?
Written by Brian Tran
Last updated: Monday, 22 January, 2007
Unlike the stocks and bonds markets, all brokerages are regulated by the SEC and by individual exchange imposing their own exams, requirements and rules that many investors take for granted that the forex market is also protected from illegal or not too clean activities.
The dealing desk broker, which is the traditional forex broker who has an in-house desk traders to control the fixed spread, even the volatile periods when major news announcements take place. They don't charge a commission on each trade but they make their gains from the bid and ask spread. They facilitate liquidity to their clients by being at the other side of the trade, this creates a somewhat misleading market because in truth the clients' trade never see the real market but only see the brokerage trader's quotes and trades. This can be compared to a poker player is playing directly against the casino house instead of with other players with the player being aware of what is happening.
The non-dealing broker is a new generation of forex brokers where they provide direct access to quote and orders to the real forex market, without a fixed spread. In this case, the trader see the real quotes as is who can see a wide spread during low volume periods, small spread during liquid periods and of course, wild spreads during news announcements. The brokers' earnings come from charging a commission per trade and not from the fix spread.
Each has pros and cons, depending on the style and needs of each trader. The fact is the smaller the spread or slippage, the better off the trader is in savings and higher the positive expectancy. Smaller spread can help a trader who is very active, he has a better chance of making a long term profit than a trade with a wider spread.
The fixed spread provided by the dealing desks can be an advantage for a trader whose main strategy is trading the news. In this case, the quotes are orderly. Unfortunately, most brokers will lock out trading during these periods. With a wide fixed spread, the strategy with less active entries and exits has a better chance of having a positive expectancy (a mathematical formula to measure from trading results to show if the strategy will be profitable in the long run) . EURUSD has the smallest spread but the other pairs the spread provided by the brokers are almost obscene. 3-pip is typical for EURUSD but 5 pips or higher. With that kind of spread, it almost guaranteed which ever active strategy used, intraday or faster, it will show negative expectancy (unlike to make money in the long run).
As for the non-dealing desk for those who trade often outside the news time can make large savings from slippage (spread). This is similar to the time when brokerages were charging full commissions where investing was an expensive endeavor or when virtually all mutual funds were loaded funds (a initial one-time fee to invest in the fund). With the coming of the discount brokerages or no-load funds, the average small retail investor have access to the markets without high costs. This is the same innovation in forex; the non-dealing desk brokers are charging only commissions (very small fee per contract) while provide natural market quotes, not a fixed 3-pip and greater spread, which is where these brokers make their revenues. In total the commissions cost less than spread or slippage costs, particularly for those not so popular pairs (non-USD or non-EUR based pairs).
As more retailers come to trading forex, there brokerage markets will decide who will last in this different types of access to trading. The trader is always advised to do due diligence, that is, research and find answers, before committing money to brokers.