When it comes to trading foreign currency pairs things have moved on from the days when transactions always involved a dealing desk, and had to be completed with the assistance of a market maker. Today, there are a couple of alternatives known as ECN and STP Forex brokers. We’ve already discussed the pros and cons of using an ECN broker, so now it’s time to concentrate on the other option. By providing you with all the important details we will make it much easier for you to decide which is your best option.
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What are STP Forex brokers?
STP stands for “Straight Through Processing”, and is a way by which customer orders are sent direct to liquidity providers without the need for a dealing desk. Two of the most important advantages are no unnecessary delays and no requotes, but there are also a number of other advantages. STP Forex brokers don’t make their money in the same way as market makers do. Instead, a commission or small markup on the spread is made. The problem with market makers is that they make money from their own client’s losses, which is seen as a conflict of interest. STP brokers, on the other hand, make the same amount of profit whether their client wins or loses, and there is therefore no conflict of interest. In fact, STP brokers can make more money when their clients win, as they get to charge a higher fee.
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What is an STP Forex broker able to offer?
Compared to other types of broker there are a number of features that make them stand out from the crowd:
- Unlike Market makers, STP brokers very rarely trade against their clients.
- There is no intervention from a dealing desk, as orders are sent direct to liquidity providers such as banks and other brokers.
- Real-time quotes are provided by STP brokers.
- Clients are able to access a greater number of liquidity providers, which means their orders are more likely to be filled.
Now you have an understanding of the benefits, let’s explain how they work…
An introduction to how STP Forex brokers work
Understanding how the Forex market works is a vital part of a trader’s journey. So let’s see if we can explain, in simple terms, what goes on behind the scenes. We’ll introduce the various parties involved in the execution of orders, and how they are placed and executed on the charts.
Brokers sites have a front end and a back end. The front end includes such features as the trading platform, charts, order buttons, trader’s accounts, and a number of other things. The back end is what goes on behind the scenes. Today’s modern technology is so advanced that communication between the front and back end is almost instant, taking just a fraction of a second.
There are a number of different parties involved in Forex trading, aside from the obvious buyer and seller. It also involves a broker who acts as the middleman between buyer and seller, and then there is a liquidity provider, which is usually a major bank, that provides the prices. Unlike the stock exchange, there is no physical location where trades can take place, and there is no physical record of the transactions and executions that participants make. Everything in Forex trading is done electronically. The STP Forex broker finds and matches orders with a counterparty who is happy to pay an agreed price. The other party could be another trader, a market maker, or a liquidity provider.
STP Forex brokers get the best of both worlds.
Generally, an STP broker will display their own quotes, linked to real inter-banking prices. An STP broker has two choices when it comes to filling orders. They can act in true STP fashion and send the orders direct to the market; or they can fill the orders themselves, much like a market maker. It doesn’t happen very often, but when a client is investing small amounts or losing trades they do have this option. This can work in their favour, as they have an opportunity to profit twice from one transaction.
Unfortunately, the STP model can also lead to requotes and rejections of orders, although not as often as with market makers. For example, should you open a large order, the broker could decide to route the order through the market; but the prices may have already changed, which leaves the broker with no option other than to reject the order and ask for the price to be adjusted by the client, or complete the order but take a risk.
So now we’ve introduced you to three different types of broker, how can you tell the difference? Is it easy to tell the difference between an ECN broker, an STP broker, and a market maker?
Recognising an ECN broker is relatively easy. Capital requirements are usually minimal. Bid and ask prices will be clearly displayed. Depth levels, another name for amounts on either side of the price, will also be clearly visible.
The difference between an STP broker and a market maker are not so easily defined. In fact, it is common to find brokers using a combination of both models. The issue with these types of broker is that they stand to make a profit if clients lose, and who would blame a trader for finding this a little unsettling? There is a light on the horizon if you use a UK- or US-regulated broker, though, as this type of activity is frowned on and the broker will have problems with their licence if they act in a way that will make a client lose money.
So there you have it. The good side, the bad side, and a brief introduction to how it all works. We’ll finish by recapping the advantages once more:
- The processing of orders is quick and efficient.
- The prices quoted for currency pairs are real, and the best possible.
- Orders are executed automatically.
- There is less possibility of requotes.
- STP Forex brokers are more interested in their clients making successful trades.
- The level of risk is reduced.
- Clients are able to see live market trends.
