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Broker Jargon Buster Part 3: What is a Prime Broker?

What is a prime broker?

Broker Jargon Buster Part 3

 

(If you missed them, then start with Part 1 and Part 2. Alternatively, you can check out all our Broker Reviews here)

 

Welcome to Part 3 of our Trading Broker Jargon Buster! This week we pick up some loose ends – terms you might hear bandied about but not sure exactly what they mean.

 

Some of these broking terms may be a bit ‘out there’ and you may feel that they don’t really affect you directly as a trade, but we are firm believers that you need to understand the rules of the game that you are playing in order to be successful.

 

Prime Broker

 

In the retail trading world a Prime Broker is the broker who ultimately takes the other side of your trade. If you trade with a ‘B Book’ broker then your Prime Broker will be the broker that you place your trades with. In this sense it contrasts with a Straight Through Processing  (STP) broker who never takes the other side of your trade and therefore is never your Prime Broker. An STP Broker will put your trade through to another liquidity provider or broker (sometimes several) who act as your Prime Broker and are on the other side of your trade.

 

Some brokers that run an ‘A Book’ will pass your trades through to another broker who acts as the Prime Broker. If your broker is using an Electronic Communications Network (ECN) then they won’t be using one specific prime broker, but it is possible that one or more of the parties that make up that trade liquidity pool will be a Prime Broker.

 

In the wider investment banking or hedge fund world, Prime Brokerage can refer to a whole heap of other services around financing, risk management, technology and other areas – but we don’t need to concern ourselves with that.

 

Global Aggregator / Aggregating Platform

 

It can sometimes seem like the list of parties who are involved in the lifecycle of your trade is never-ending. This is particularly the case when you trade with an ECN broker or Direct Market Access (DMA) broker who you are told is using an ‘Aggregator’ of some kind.

 

What this essentially means is that they are using a piece of software that pulls in (aggregates…) prices from a variety of different liquidity providers or ECNs. The aggregator either finds the single best party to take all of your trade, or aids in the process of breaking it up into its various pieces and using a number of different counterparties.

 

This is not an area that adds extra cost to your trading as it is simply a way of finding the best price.

 

Closely related is the term Order Management System or OMS – for our purposes, they are basically the same thing.

 

Market Maker Brokers (those running a B Book) will have no need for an Aggregator or OMS as they take the other side of your trade in its entirety, and STP brokers who use only one Liquidity Provider (Prime Broker) don’t need to use one either. But it can be an essential part of broker technology for those brokers that use multiple liquidity providers or an ECN.

 

Bridging Provider / MT4 Bridge

 

Not many people are aware that MetaTrader 4 (MT4) was originally built to be used just by Market Maker brokers. As traders are becoming more sophisticated and lasting longer in the market, many are looking to move away from ‘trading against’ their broker towards an STP, DMA or ECN model. However, many of these traders still want to use the tried and testing MT4 platform.

 

For this reason, a number of ‘MT4 Bridge’ providers have entered the market since about 2006. These are often called MT4 ECN Bridging or Straight Through Processing Bridging providers. It essential allows traders who use MT4 (and the brokers that provide an MT4 platform) to access the interbank market or a specific ECN – it ‘bridges’ the gap between a trader’s broker and their liquidity providers.

 

Regulation

 

We’ve left this to last, but it is probably the most important part of choosing a broker. There are a number of different regulatory districts you can choose from, but the number one rule is:

 

  • You must not trade with an unregulated broker. It is madness, and totally unnecessary.

 

There are zero benefits to trading with an unregulated broker, and I am sure that any you could think of cannot outweigh the negative that they could just run off with your money. On a slightly less extreme scale, if they don’t segregate your client funds from their own funds (which they would have no obligation to do as they are not regulated) and went bust (highly likely) then you will probably lose all of your money.

 

So, now that that is out of our way, lets look at the regulated options. Regulation is different in all countries and what you are allowed to trade and who with, varies from country to country.

If you live in the United States, then you will have to trade with a US regulated broker. Since the collapse of the US arm of FXCM, your options have become rather limited. But look out for a broker regulated by the CFTC.

 

If you live in the UK, Europe or the Middle East then you will likely look for a broker regulated by either the FCA (the UK regulatory body) or CySec (the Cypriot regulatory body). The FCA is possibly slightly more stringent and has better depositor protection schemes than CySec but CySec is without doubt a mature regulatory environment and home to many reputable Forex Brokers.

 

ASIC in Australia is another good regulator and if you live in that part of the world then you probably want to be looking out for an ASIC regulated broker.

 

This is just an overview and we will write up a full piece on the different regulatory bodies and rules soon!

 

Conclusion

 

Ok so a lot of this is quite advanced – maybe you don’t really need all of this knowledge to trade once you are set up with a good broker. But, it is my belief that you need to have a solid grasp of the brokerage world in order to be able to choose the correct broker for you and make sure you continue to trade with the best broker you can.

 

Using the correct broker won’t make you a profitable trader – but if you want the best chance of becoming and staying profitable then you are going to want to use a broker that you trust and whose model of trade execution you understand.

 

If you are still looking for a bit more information to make up your mind on the right broker for you, then there is a wealth of information on the Two Blokes Trading Broker Review Pages.

 

Two Blokes Trading

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