For most day traders, trading is mostly confined to technical/fundamental analysis and well, the obvious result of executing their orders. Understanding what happens when an order is triggered gives far better insights into how your trades are processed.
In this article, well learn about how orders are executed, especially in terms of forex brokers. To keep it simple and concise, well only focus on online forex brokers.
In order to understand forex execution process, one must first know the types of orders that can be placed. They are broadly classified into Market Orders, where you buy or sell at the current market price, or pending orders where your order is triggered only when your specified price is reached.
But, it doesn’t end quite there as there is a deeper, complex process that eventually decides on whether your order is filled or killed.
Order Processing – Dealing Desk Broker
When trading with a Dealing desk broker, your orders are filled by the brokerage. In most cases, your BUY or SELL order is filled by the brokerage taking an opposite position to your trade. So if you were to buy EUR/USD at 1.302 with a dealing desk broker, your order would be filled by the brokerage taking a sell order at 1.302. Obvious from this, one party has to win, while the other loses.
In most cases, a dealing desk broker opts for any of these following methods to match your orders. We stick to the simple ways of matching orders.
Match your orders with another client: The most risk free way for a market maker to trade would be to match your order against another of their trading clients, this way the broker makes their spread market from both ends.
However, such execution cannot be always filled if the broker has a low volume of clients.
Match your orders directly: The most common way is for the broker to match your order, in other words, take an opposite position to your trade. This happens when there are no clients who are willing to BUY or SELL at your price.
This is risky because the brokerage can see losses should the market move in your favor
Match orders but hedge the risks: In cases where there is a strong move in the markets in one direction and when the broker is forced to take the opposite end of your trade, the brokerage can actually open another position (similar to yours) in the markets to offset their risks
As you can see from the above, there is considerable risk involved when you are trading with a dealing desk broker. There have been many reported incidents when dealing desk brokers have outright cut off their winning clients from trading or put their trading account under supervision so as not to incur further losses.
The dealing desk broker’s model is often cited in their Conflict of Interest Policy.
Another issue that comes out of order execution is Re-quotes which is common when trading with a dealing desk broker.
A re-quote is your broker telling you that they could not fill the order at a price you specified and alert you to the next best available price.
Re-quotes are common with market orders. While there might be legit reasons for a re-quote (for ex: during high market volatility), dealing desk brokers can use re-quotes to their advantage in order to fill your order at a price they consider better for their counter party trade.
Order Processing – Non Dealing Desk Broker
Non dealing desk brokers make money either by charging commissions or adding a spread mark up to your price. However, they do not trade against their clients but pass on these orders either within their existing client base or onto their liquidity network.
The liquidity network is made up of large institutions as well as a couple of other NDD brokers.
The Straight-Through-Processing model automatically matches your orders against other clients within the same network.
The picture below illustrates the order execution for NDD and Dealing Desk Brokers.
Given that the order execution is quite complex, this has given some rogue forex brokers to take advantage of the general public at large. By advertising themselves as a STP/NDD broker, brokerages continue to fill the client orders internally.
At the same time, there are some legitimate NDD brokers who charge a spread mark up instead of commissions. This is because the fee involved in connecting to a liquidity network is quite high is purely based on trading volumes.
A forex broker will smaller volumes, would opt for a spread mark up. On the other hand, a brokerage such as LMAX exchange, which operates as a MultiLateral-Trading-Facility (MTF) charges commissions only due to their already high volumes.
So the question of whether you should pay attention to how your orders are executed, comes down to that of personal choice. For experience trades, order execution plays an important role, and it is obvious that such traders prefer a non-dealing desk broker.
For the most part, where the retail trading group is made up of novice traders with low volumes, you could be excused for not wanting to know about the order execution.