Market makers are liquidity providers that continuously provide price quotes on both the buy and sell side, regardless of their own view of the asset's future movements.
When you trade, your counterparty (the person on the other side of your trade) is therefore a market maker. Market makers go by other names too, such as liquidity provider or dealing desk broker. When you want to trade a currency pair, silver or Bitcoin, chances are that you're dealing with a market maker.
Market makers are counterparties to your trade, which means that when you want to buy or sell a currency pair, for example, the market maker will always take the other side of your trade, even if they think the trade is likely to be in their best interests.
Since market makers are the counterparty to your trade, they win when you lose and lose when you win. This is why you will sometimes hear them referred to as a "b-book" broker, because they take the other side of the account book.
What role do market makers play?
Market makers (typically international banks, financial firms or brokers) play two important roles that make trading possible.
Market makers provid liquidity to the market
On the one hand, they provide liquidity to the market, which is why they are also referred to as liquidity providers. They help manage available liquidity so that supply meets demand in real time.
Market makers ensure that there will be a counterparty to each trade
On the other hand, market makers guarantee that there will be a counterparty to the trade. They continuously provide buy and sell quotes as long as they have liquidity. Without market makers, assets would be illiquid, as it would be difficult to find someone with an opposing view to the trade you want to make.
How do market makers make money?
We say that Market Maker brokers "make the market" as they set both the buy price and the sell price of a trade. They provide their own quotes (often the same as interbank prices), which allows you to buy at the best available "bid" price and sell at the best offered "ask" price. This difference between the bid price and the ask price is known as the spread and is the broker's source of profit.
The higher the ask price compared to the bid price, the more profit the brokerage firm will make. This spread compensates the market maker broker for the risk it takes on with the trade.
These brokers can also lose money if the market moves against them and they are unable to react quickly enough to these events. To protect against crippling losses when the market turns against them, they also use hedging strategies.
Market Makers are also known as dealing desks
To trade, you'll almost always have to deal with a market maker, which means using the services of a broker that is either a dealing desk (DD) or no dealing desk (NDD) broker.
Dealing Desk brokers will always be the counterparty to your trades, so you're trading directly with them. Even if the broker chooses to use another third-party liquidity provider, you're still dealing with the DD broker.
This is different from an NDD broker that connects professional and retail traders with liquidity providers using execution methods such as electronic communication networks (ECN), straight-through processing (STP) and Direct Market Access (DMA). STP and ECN brokers' traders don't deal with the broker itself.
What does a Dealing Desk broker do when it receives a trade request?
DD brokers have the ability to evaluate each trade request that a trader submits. From there, they internalise the trade or engage a third-party liquidity provider to complete the trade. You will never know how the broker obtains the cash to carry out your trade.
Dealing Desk brokers use their own cash
If they carry out the trade internally, here's what happens:
- They may find another trader who'll act as counterparty: If clients make buy or sell offers that offset the other party, then the broker can use each opposing trade to complete a trade.
A DD broker will typically choose to fulfil a trade on its own whenever they can:
- Speed is a priority: A broker that uses its own resources can be faster than connecting with a liquidity provider.
- When a trade size is too small: Liquidity providers (wholesalers) don't find it profitable to trade small positions. However, DD brokers want to attract and retain their clients and will therefore fill this gap.
- It reduces costs: Brokers can save costs by using their own liquidity.
- It makes fixed spreads convenient: Liquidity providers don't offer fixed spreads. DD brokers can therefore better control the risks associated with fixed spreads by using their own liquidity.
DD brokers will transmit an order to a third-party market maker when:
- They can't find a trader to internalise the transaction: if they can't find a corresponding order from their clients, they can call on a liquidity provider.
- Lack of liquidity: If the dealing desk lacks liquidity, it may need to bring in a liquidity provider.
- Large positions: If the trader's position is exceptionally large, the dealing desk might not have enough cash liquidity on hand.
- Incentive: In some cases, third-party liquidity providers sufficiently incentivise DD brokers to use them.
When a broker uses a market maker or a third-party liquidity provider, we say that it is hedging its position.
Can we trust market makers' price quotes?
As market maker brokers provide their own quotes and win when you lose, it's easy to think it's in their interest to manipulate spreads in their favour. Rest assured, though, this doesn't happen, at least not with brokers that are overseen by a good regulator.
Reasons why market makers' spreads aren't manipulated:
- Regulation: Good financial regulators such as FCA (UK), CySEC (Cyprus), NFA (USA), ASIC (Australia), AMF (France) require brokers to offer fair prices. Tier 3 regulators such as IFSC (Belize), FSB (Bahamas) may not be as strict about this.
- Competition: Competition between brokers is intense, which guarantees prices close to (or even identical to) interbank rates.
- Liquidity pools: To ensure price integrity, many market makers simply match prices or aggregate prices from a liquidity pool.
Market makers: the good and the bad revealed
Market makers offer both benefits and drawbacks which you need to keep in mind.
Benefits
1. Commissions are included in the spread
There are two types of trading accounts.
- Standard accounts: commission-free or with commission fees included within the spread.
- ECN or Pro accounts: with interbank spreads plus a commission.
DD brokers offer standard accounts, so although the spreads are wider, this doesn't necessarily translate into higher trading costs. You will need to compare the spreads of DD brokers with those of ECN brokers and also add their commission costs to determine which type of broker is cheapest.
While standard accounts may be a bit more pricier, new brokers and long-term traders may find the lack of commission an advantage due to their simpler cost structure.
2. Spreads can be fixed or variable
Market makers can offer fixed or variable spreads, it would be very unusual for a no dealing desk broker to offer fixed spreads.
Since market prices are constantly changing, major liquidity providers have no interest in taking the risk of offering fixed spreads. Dealing desk brokers, on the other hand, may be willing to take this risk to appeal to traders who prefer stable spreads in times of market volatility.
3. A greater choice of trading instruments
DD brokers generally offer more trading instruments. While almost all brokers offer CFDs on forex currency pairs such as GBP/JPY, indices, copper and Bitcoin, you can find DD brokers that offer assets off the beaten path such as bonds, interest rates, futures and vanilla options. You may also find that they offer a wider variety of such products such as cross currency pairs like EUR/CHF and exotic currency pairs.
4. More features - risk management, training
DD brokers generally offer a more comprehensive trading experience than NDD brokers. The features that DD brokers typically offer are:
- Their own in-house trading platform: designed specifically for their clients. NDD brokers use common trading platforms like cTrader, MetaTrader 4, or MetaTrader 5.
- Extensive risk management: tools to better manage trading risks, such as guaranteed stop losses.
- Educational libraries: (sometimes free). Covering topics such as online trading, forex trading and trading strategies.
5. No minimum deposits
Many NDD brokers generally require a minimum deposit to open an account, although it is usually very low. DD brokers rarely have a minimum deposit requirement.
Drawbacks
1. A conflict of interest
As Dealing Desk brokers are your counterparty, there's an innate conflict of interest since they win when you lose. Although most brokers operate with integrity, keep this in mind!
2. A lack of transparency - you can't see interbank prices
As DD brokers act as an intermediary between the trader and liquidity pools, you won't have any visibility in terms of the interbank prices offered by liquidity providers.
3. The broker may not accept all trades, or it may provide requotes
DD brokers may reject your trade or offer a revised quote (called a "requote").
For example, if a broker knows that the transaction is very large and very profitable, he can take a closer look. At this point, he can either process the order internally, forward the order to an external liquidity provider, or reject the order.
4. Artificial quotes
DD brokers create their own market and can therefore set their own prices. Although these prices are generally aligned with interbank prices, they are always set by the broker.
5. Spreads are wider
Wider spreads can lead to higher transaction costs. Generally, if you are a frequent trader, you will probably prefer an ECN or STP trading account with commissions.
6. Scalping is often forbidden
DD brokers lose money when you profit. So they generally don't allow scalping strategies, where traders aim for small profits with lots of quick trades that don't give brokers time to hedge the risk.
7. Social trading tools are generally not available
Many Dealing Desk brokers have proprietary trading platforms that don't allow the integration of third-party services. For this reason, most social trading tools aren't available.
8. Proprietary trading platforms
Although some say this is a benefit, since good trading platforms are designed to meet the needs of traders, it can also be a weakness. Many brokers design their trading platforms so that only their traders can use them, with the aim of locking the client into their ecosystem. This can make it difficult to leave the broker if you want to sign up with a new broker.
Conclusion
Market makers play a vital role in making trading possible. Without them, it would be difficult to find a party with cash ready to take the other side of your trade.
When you choose a forex broker, you have the choice between a broker with or without a dealing desk. The former is almost always a market maker, while the latter offers ECN, STP or DMA-type pricing.
This page has looked at how a market maker works in forex trading. These types of brokers offer a number of benefits, but also some drawbacks. You'll certainly find that market maker brokers have features that you won't find in an STP or ECN broker, however, dealing desk brokers remain popular.
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