In the forex trading world, there are two primary business models: A-Book (Non-dealing desk) and B-Book (Market Maker). They define the way Brokers will provide liquidity for transactions made by clients on their trading platform. In other words, each Broker needs to decide if they want to be an intermediary or a counterparty for them. However, it doesn’t mean that these two models are mutually exclusive; neither are they the only options.
What is an A-Book in the forex business?
A-Book is a type of execution forex model. It is also known as an STP (Straight Through Processing) Broker or a non-dealing desk Broker.
In this model, Brokers earn money by charging commission or making a slight change in the spreads. It works through a bridge that connects a trader’s terminal directly to a liquidity provider.
When a Broker operates under the A-Book model, it passes the orders directly to the Liquidity Provider. Depending on the LP’s set up it can stay within its liquidity pool or be passed to other LP’s pools. A liquidity pool consists of many entities acting as a counterpart to the trades flowing out from your forex Broker.
These Brokers make money by increasing the spread or by charging commissions on the volume of orders. Therefore, there are no conflicts of interest; they earn the same amount of money with both winning and losing traders. They do not take many risks but potentially achieve lower profits because they earn only on margins/commissions.
This type of model (No Dealing Desk) operates as a middleman between the trader and the market. By choosing to deal through an A-Book Forex Broker, the trader cuts out both the market maker and their dealing desk. Therefore removing the parties that would otherwise profit from their transactions.
What are the advantages of using an A-Book Broker?
The main advantage of using an A-Book Broker is a smaller number of conflicts of interest, as the profit of their clients does not have a negative impact on their business.
In this model, prices are acquired from several market participants instead of from just one liquidity provider. This can lead to better fills, tighter dealing spreads and more accurate quotes. Especially when compared with the service provided by a Forex Broker, which only has a single source for its quotations.
Usually, traders prefer to execute their trades through an STP Broker model, as it often requires no Dealing Desk. This way the Broker is more transparent with the client’s trades. That’s because, the client is entering trades into an actual market, instead of an artificial one (possibly created by a Market Maker).
There are also some downsides to using A-Book. The orders are processed directly to the liquidity pool, thus traders will witness variable spreads. Those spreads can be very tight when liquidity is high, but they can vary significantly during low volume periods.
That becomes even more noticeable when someone trades financial derivatives on exotic currency pairs such as the USDNOK or EURZAR.
Additionally, it is worth mentioning that you can see the spreads on such currency pairs tighten during regular market hours. Nevertheless, during off-market hours (such as the early Asian trading session), you will experience precisely the opposite, meaning that the spreads will probably widen.
How do B-Book Brokers work?
B-Book forex model is also known as a Market Maker. In this model, a Broker chooses to trade against his clients. There is no external liquidity pool where the Broker executes trades. In this case, it acts as a counterparty to his trades.
In simple terms, if a trader places a buy order, a Broker will be selling to him and vice versa. Thus, it is clear that this type of model generates conflicts of interest between Brokers and their clients.
However, in certain instances, trading with a B-Book Broker could be beneficial for traders. For example, traders can get guarantee fills on their trades. In addition, even when liquidity is low, traders get a good execution of orders because the Broker acts as the market maker.
Another good reason to choose a B-Book Broker is that a B-Book model offers fixed spreads, whether you trade during peak market hours or off-market hours. B-Book forex model typically charges a fixed spread you pay for every time you open or close a position. This again has some advantages and drawbacks. For one, having fixed spreads makes it easier to trade when there are market shocks. But at the same time, you will have to improve your trading strategy to account for the fixed spreads.
That’s why Forex Brokers with larger market makers use a hybrid model. It involves placing transactions in A-Book or B-Book based on traders’ profiles.
The hybrid business model
The popularity of the hybrid model is understandable because it allows Forex Brokers to increase their profitability and credibility. It also allows Brokers to earn money from profiting traders by sending their trading orders to liquidity providers without generating conflicts of interest.
To successfully identify profitable and unprofitable investors, Forex Brokers have software that analyzes their clients’ orders. For example, they can filter traders by the amount of their deposit, the leverage used, the risk taken with each transaction, and the use or non-use of protective stops.
The hybrid model does not have to be bad for traders either. After all, the profits gained from traders placed in the B-Book allow hybrid Brokers to provide all their clients with very competitive spreads. That’s true whether they are profitable or not. However, if a hybrid Broker manages the risk of B-Book poorly, he can lose money and thereby threaten the company. That is perhaps the biggest disadvantage of this system.
The types of hybrid models:
- The Broker can divide his customers. Send some of the customers to the Liquidity Provider and keep some in house.
- The Broker can divide customers’ trades. Keep some trades in house and send some to the Liquidity Provider.
- The Broker can decide to send all trades of a specific size to the Liquidity Provider and keep the rest in the house.