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 Broker 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 for the transactions or a counterparty. However, it doesn’t mean that these two models are mutually exclusive; neither are the only options.
What is an A-Book in the forex business?
A-Book forex model is known as STP Broker (Straight Through Processing), a type of execution model also called 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, a trader cuts out both the market maker and their dealing desk, who will likely profit from their transactions.
The main advantage of using an A-Book Broker is that there are fewer conflicts of interest as the profit of their clients does not have a negative impact on their business.
Also, to use an STP Broker is greater liquidity as 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 when compared with the service provided by a Forex Broker, which only has a single source for its quotations.
Traders most of the time prefer to execute their trades through an STP Broker model as it often requires No Dealing Desk, meaning that the Broker is more transparent with the client’s trades as the client, in reality, is entering trades into an actual market instead of an artificial market that a market maker may create.
Although there are some downsides to using A-Book, because the orders are processed directly to the liquidity pool, then traders will witness variable spreads. Those spreads can be very tight when liquidity is high, but the spreads can vary significantly during low volume periods.
The spreads can be very tight when liquidity is high compared to the low volume period when the spreads can vary remarkably. That becomes even more noticeable when someone trades financial derivatives on exotic currency pairs such as the USDNOK, EURZAR and so on.
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 wide.
How B-Book Brokers work?
B-Book forex model is also known as a Market Maker; in this type of model, a Broker chooses to trade against his clients, as there is no external liquidity pool where the Broker executes trades. In this case, it acts as a counterparty to his trades.
To explain this in simple terms, if a trader places a buy order, the 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 that 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, the use or non-use of protective stops, etc.
The hybrid model does not have to be bad for traders either because the profits gained from traders placed in the B-Book allow hybrid Brokers to provide all their clients with very competitive spreads, regardless of whether they are profitable or not. The main disadvantage of this system is that if a hybrid Broker manages the risk of B-Book poorly, he can lose money and thereby threaten the company.
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.