They may use electronic communication network ECN methods to make it work. The implications of dealing directly with the interbank market are twofold: the size of currency rate spreads and the amount of additional cost to make a trade. With an NDD broker, traders are exposed directly to the exact spread available to retail customers on the interbank market.
Depending on the currency pair being traded, and depending on the dealing-desk broker being compared, NDD brokers may offer wider spreads. That means the cost to make a trade is greater since retail traders must give up the value of the spread with each round-trip trade. Additionally, an NDD broker may charge an exchange fee or a commission. Because they are passing the spread directly through to the customer, they have to charge fees some other way or face making no money for their services. In these two ways trading with an NDD broker may become more expensive over time by comparison to dealing-desk brokers.
Market Making Brokers An NDD broker stands in contrast to market-making brokers who attempt to stand in between customers and the interbank market as a means of making trades theoretically quicker and more efficient. To do so, they accept the risk that they can anticipate changes in the market well enough to shield against market risk. The intent, on their part, is to make trading convenient and less expensive so retail traders want to do business with them.
To do so they do not aid the trader working directly with the interbank market, but rather make a market, or in other words offer trades, where they can bring the spread potentially the same or even closer than the interbank market rate. In such a trade, the retail trader benefits by paying less money.
The broker benefits because they get to keep the entire spread. There are two main strategies for hedging in the forex market. The second strategy involves using options, such as buying puts if the investor is holding a long position in a currency. Forex hedging is a type of short-term protection and, when using options, can offer only limited protection. Although selling a currency pair that you hold long, may sound bizarre because the two opposing positions offset each other, it is more common than you might think.
Interestingly, forex dealers in the United States do not allow this type of hedging. To create an imperfect hedge, a trader who is long a currency pair can buy put option contracts to reduce downside risk , while a trader who is short a currency pair can buy call option contracts to reduce the risk stemming from a move to the upside. Imperfect Downside Risk Hedges Put options contracts give the buyer the right, but not the obligation, to sell a currency pair at a specified price strike price on, or before, a specific date expiration date to the options seller in exchange for the payment of an upfront premium.
The trader could hedge risk by purchasing a put option contract with a strike price somewhere below the current exchange rate, like 1. Bear in mind, the short-term hedge did cost the premium paid for the put option contract. After the long put is opened, the risk is equal to the distance between the value of the pair at the time of purchase of the options contract and the strike price of the option, or 25 pips in this instance 1.
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