Dealing Desk Overview

Dealing Desk Overview

In the past, most retail traders have been accustomed to trading with a standard dealing desk operated by the FCM where their funds are held and platform connected to. A dealing desk provides traders with access to trade execution, allowing clients to access the FX market when they want and take advantage of price movements between currencies. The dealing team is tasked with generating revenues for their firm using the transaction flow generated by client orders. FDMs with Dealing Desk business models therefore rely on human intervention to generate revenues, so all trades placed by clients of the firm are seen by at least one human being.

How it works:

A Dealing Desk works as the counter party to your trades. If you buy 100,000 EUR/USD, then the dealing desk has sold those EUR/USD to you. You are long; the Dealing Desk is short. The dealers now have a choice; they can buy 100,000 EUR/USD from someone else to cover their short position or they can choose to hold their short position that you have given them and wait for the position to be offset either by another client’s order, or by you closing your position. If the dealing desk decides to cover the position that you have given them (your long 100,000 EUR/USD causes the dealing desk to be short 100,000 EUR/USD), they will make money if they buy back at a lower price, or lose money if they buy back at a higher price. If the dealing desk chooses to hold their short position that you have given them, they will make money if an offsetting transaction takes place at a better price level, and lose money if the offsetting transaction takes place at a worse level.

In the institutional market, most all dealing desks (and they are all dealing desk models at the highest interbank level) seek to make money on a transactional basis which means they cover the risk they are given by client orders and attempt to make money on each transaction. In the non-institutional market, another dealing desk model is prevalent. Armed with the knowledge that in any leveraged market, such as Foreign Exchange, the majority of participants lose money, many successful dealing desks never offset the risk exposure that they are given by client orders. Instead they act as a Las Vegas casino, warehousing all the client risk knowing that most participants will lose money and therefore the dealing desk will harvest the aggregated client losses. Since Foreign Exchange is a “zero-sum” game, any money lost by one participant is gained by another.

The problem with the non-institutional dealing desk model is that by holding the risk given to them by clients’ orders, the dealers have incentive to want the clients to lose on their trades. The retail FX industry has been beleaguered by firms that held client risk and played games with pricing and execution of orders to help the dealing team make more revenues. But, there is a benefit to clients of this dealing desk model…

FDMs that have a traditional retail dealing desk tend to have slightly better execution of client orders during times of high volatility than FDM’s that have gone to a ECN model. That is because the traditional dealing desk will accept all orders knowing that a majority of client trades will lose money. The retail dealing desk model is not particularly worried about a pip or two here or there. So, these FDMs allow more client orders to be executed even if the order is not “at market” during a time of high volatility.

Pros:
• The trading platform usually comes with free charting software and news feeds. (For related reading, see Demo Before You Dive In.)
• Some of them have more user-friendly trading platforms.
• Currency price movements can be less volatile compared to currency prices quoted on ECNs, although this can be a disadvantage to scalpers.

Cons:
• Because they may trade against you, market makers can present a clear conflict of interest in order execution.
• They may display worse bid/ask prices than what you could get from another market maker or ECN.
• It is possible for market makers to manipulate currency prices to run their customers' stops or not let customers' trades reach profit objectives. Market makers may also move their currency quotes 10-15 pips away from other market rates.
• A huge amount of slippage can occur when news is released. Market makers' quote display and order placing systems may also "freeze" during times of high market volatility.
• Many market makers frown on scalping practices and have a tendency to put scalpers on "manual execution", which means their orders may not get filled at the prices they want.



ECN Overview

The ECN clearing model is a bit cleaner (more accurate) for clients though not necessarily better. In an ECN model, all client orders are passed through the FDM’s trading platform to an ECN for execution. In effect, these firms have automated their dealing desk so that the firm does not take on any financial risk. These FDM’s are really just technology providers that allow clients to access the FX market through their platform. So for firms that use an ECN business model, they generate their revenues by taking the prices provided by the ECN and marking those prices up, either by adding to the spread or by charging a commission. FDMs that use an ECN dealing model are more dependant on technology than traditional dealing desk model firms.

How it works:

When a client order to buy 100,000 EUR/USD is entered into the FDM’s trading platform, that same order to buy 100,000 EUR/USD is sent to the ECN that is linked to the FDM’s platform. If and when the client order is executed by a participating bank on the ECN, an electronic message is sent to the FDM’s trading platform confirming to the client that their order has been accepted an executed. There are a number of technology “bridges” that have to be working in order to allow for smooth operation. First, the client’s order on the FDM’s platform. Second, the bridge from the FDM’s platform to the ECN. And third, the return of information across those bridges. For these ‘no deal desk’ FDM firms, there is no financial risk being taken so long as the bridges are working correctly. This business model involves less risk, but does not have the high revenue margins associated with traditional dealing desks.

The main problem with this model is the rate of execution of client orders. There are two factors at play here. The first is the number of “bridges” that an order must pass over before the trade is confirmed as executed. The more bridges used to carry an order, the slower the confirmation. The second factor is that ECNs tend to have more price changes than traditional dealing desk platforms and that can lead to poor execution rates. If a client attempts to buy EUR/USD at a price of 1.2978 but in the milliseconds it takes for that order to get to the ECN the price has changed to 1.2979, the client’s order is not executed. In contrast, traditional dealing desks do not reflect every single price change and are more likely to have executed the above example order at the original price.

Pros:
• You can usually get better bid/ask prices because they are derived from several sources.
• It is possible to trade on prices that have very little or no spread at certain times.
• Genuine ECN brokers will not trade against you as they will pass on your orders to a bank or another customer on the opposite side of the transaction.
• Prices may be more volatile, which will be better for scalping purposes.
• Since you are able to offer a price between the bid and ask, you can take on the role as a market maker to other traders on the ECN.
Cons:
• Many of them do not offer integrated charting and news feeds.
• Their trading platforms tend to be less user-friendly.
• Because of variable spreads between the bid and the ask prices, it may be more difficult to calculate stop-loss and breakeven points in pips in advance.
• Traders have to pay commissions for each transaction.



SO WHAT TYPE OF FDM EXECUTION MODEL IS BEST FOR MY TRADING?

Great question and there is no standard answer, but this is where you can gain a significant advantage over other traders who do not have the correct trade set up. There are a number of pros and cons to each execution model (ECN vs. DD) and depending on your needs may or may not weigh heavily on your decision.

Consulting with an established Introducing Broker is usually the right step to take in getting paired up with a firm that can properly cater to your trading. In such an ever-changing industry, an IB can advise and consult for multiple FDMs and help you make the best decision on where to keep your money and trade FX.

A reputable IB with strong relationships in the FX industry should always be on top of any industry changes and advancements and inform you before anyone else. Additionally, they are usually the first to know of any new information that may even slightly impact your trading so it’s a good idea to always speak with your IB about any new brokerage services that you are considering.

With so many different brokers to choose from and so many different ways to trade Forex, it’s imperative to your trading performance that you are trading with an FDM that caters to your needs and meets your requirements. Always be wary of what you may read on forums and be sure to steer clear of those guys with the “guaranteed” returns…

It’s strongly suggested that if you plan to trade Forex or are currently active in the market that you contact a licensed and registered IB that has already conducted the due diligence necessary on the FDMs available to you to make a qualified recommendation.