Today, we will discuss the main models of order execution used in Forex by broker companies.
How do brokers work?
A broker is an agent between the parties of a trade in a financial market. Based on a signed contract, a broker helps its client to make market operations for a certain reward. Any broker must have a license for its professional activity with all the information about the license available on the broker’s website.
👉 More information about how to choose a forex broker, you can find in this article.
Here are the main terms used in trading operations:
- an order is literally an order given by the client to the broker company; the order can be to buy or to sell the financial instrument. |Orders can be either market or pending;
- a trade is the fact of buying or selling a certain financial instrument. Buying happens at the Ask price and selling — at the Bid price. Trades can be a result of the execution of a market order or the triggering of a pending one;
- a position is a market commitment, the number of sold and bought contracts for a financial instrument. A long position means that you have bought an instrument expecting to hold it until the price grows while a short position means that you must supply the instrument in the future, hoping that the price will fall.
The general scheme of order processing by the broker looks as follows:
- the trader on the trading platform gives an order to the broker for a trade with certain parameters.
- On the broker’s server, the trade is checked for correctness (the correctness of the price, the balance on the trader’s account, etc.).
- Upon checking, the order is processed on the trading server. Then it can: be executed, be rejected, expire with time, or called back by the trader.
- As a result of the market order execution or the triggering of a pending order, a trade is made.
- As a result of a trade, a position is opened. If there is already an open position by the instrument, it can be increased or decreased in terms of the volume, closed or reversed (depending on the position record system that the trader uses).
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The system of recording open positions
For recording open positions, broker companies use two main systems — netting and hedging.
- Netting allows only one open position in any direction for one instrument. This system is used all over the stock market. A trader may not open a buying and selling position for an instrument at once, they will mutually close. Meanwhile, positions in one direction get added to each other.
- Hedging allows any number of open positions for one instrument in both directions. The system was implemented to make easier the life of traders who want to trade one instrument through different strategies.
👉 To find out more about Netting and Hedging accounts, please see this article.
Instant Execution
Instant execution is a way of order processing that presumes order execution exactly at the price specified by the trader — or no execution at all. The trader can set the price deviation channel: if during order processing the price changed but remained inside the channel, the order is executed at the corrected price. Otherwise, the order is not executed at all.
The peculiarity of instant execution is frequent requotes. A requote means that the order was rejected because the price had changed, and the trader was suggested sending in another order for opening/closing the trade at the new price. Requotes are the main disadvantage of such execution because the trader may miss the rejection or be too late to open a position in a strong price movement.
Market Execution
Market execution means that the order is executed at the current market price. Orders are executed instantly, with a guarantee and without requotes at the current market price, even if it changed a bit during order processing. The trader agrees in advance that the execution price may change a little during order processing. This is the most popular type of order execution in Forex nowadays.
The peculiarity of market execution is slippages. Slippage is a deviation of the execution price due to a change in the market price during the execution time. To put it simply, this is the difference between the opening/closing price in the order and the factual opening/closing price of the position. Slippages can be either positive or negative.
Dealing Desk (DD)
Dealing desk is a technology of executing orders via a dealing center, where trading operations are carried out inside the company, most often without even going to the outer market. In this case, the broker, receiving an order from one trader, tries to cover it up by an order of another trader inside the company. Alternatively, a part of the position is covered by an opposite position inside the company and the remaining part is united into a separate position and goes to the outer market.
This model normally presumes the instant execution of orders. When trading via DD, conflicts of interest are possible. In this case, a broker acts as a contractor for the trader, and the trader’s losses may become the broker’s profit. If the broker is unscrupulous, they may even manipulate the quotations to increase their profit.
No Dealing Desk (NDD)
When trading via NDD, the broker sends all orders to the interbank market (to liquidity suppliers, banks, other brokers, etc.). This means the broker company does not act as the other party in the trades of its clients but works as an agent between two opposite parties of a trade.
The NDD model uses the market execution type. Orders are processed automatically. NDD trading increases the speed of order processing and decreases spreads to a minimum. This scheme presumes no conflicts of interest — the broker’s profit consists of a part of the spread and a small commission fee for a fixed trade volume.
Direct Market Access (DMA)
Direct Market Access (DMA) is a technology that sends all orders to the liquidity supplier, avoiding brokers. DMA orders go directly to the exchange or interbank market, which increases the speed of order execution and allows trading at the best prices.
Thus, traders get maximally transparent order execution at the best market price (Best Bid — Best Ask). Each order gets into the market depth of the liquidity supplier. The advantages of DMA are speedier order execution, best prices from different liquidity suppliers, fewer expenses on trades.
Straight Through Processing (STP)
Straight Through Processing (STP) is a technology that brings the orders of a broker’s clients directly to liquidity suppliers, or, so to say, the interbank market.
The process of STP trading:
- The trader makes a trading decision and places an order in the terminal;
- The order is sent to the server of the broker company;
- The broker company automatically sends the order to the aggregator. To put it simply, an aggregator is a place aggregating orders that are then sent to liquidity providers;
- Liquidity providers regularly provide their quotations for this or that asset by a safe and fast protocol;
- Thanks to this technology, the order is executed at the price offered by the liquidity supplier.
Electronic Communication Network (ECN)
The ECN is a special network that carries out Forex trades without agents. All orders of the traders using the ECN are united in a base called market depth. A special algorithm processes the applications automatically.
The scheme of trading via the ECN:
- The trader makes a trading decision and places an order in the terminal;
- The order is sent to the server of the broker company;
- The broker automatically sends the order to the market depth of the ECN where the trader sees their order alongside the orders of other market players with volumes and prices;
- Inside the ECN, the best Ask and Bid prices form;
- Thanks to high liquidity inside the network, the trader’s volume is executed fast and with minimal slippages.
👉 More information about ECN accounts, you can find in this article.
A hybrid type
Sometimes brokers use hybrid models of order execution, uniting some traits of the models above. The most widespread hybrid model unites STP with the ECN or DMA. In hybrid models, only market execution is available because quotations are taken directly from liquidity providers (thus, there are no requotes).
A hybrid model somewhat reduces the expenses of the broker company and provides the best conditions to its clients. The client gets fast execution, minimal spreads and commission fees, an opportunity to trade small volumes and use various trading strategies.
Which model to choose?
Each type of trading has its peculiarities, that is why the trader should choose one based on their trading style and preferences. Choosing an order execution type, the trader normally chooses between one of the two options: either execution at the exact price but not guaranteed or guaranteed execution but at any available price.
By Dmitriy Gurkovskiy, Chief Analyst at RoboForex
