ECN, STP and DMA Forex and CFD Brokers Versus Market Makers
Differences in Business Models and Why It’s Important
By Shawn Bailey, Hawk & Campbell Securities, June 12, 2015
Every Forex trader, whether an expert in day trading or a long-term currency trading visionary, is in a constant search of one top Forex broker that provides not only best trading technology, but also stability and confidence of a bulletproof online trading platform. Picking the right partner for your online trading is a question of knowledge and deep understanding of underlying business models that govern every step your Forex broker takes.
This article investigates the two predominant business models in online brokerage of market-making and straight-through-processing (STP), explaining critical subtleties in Forex dealing that are often ignored by traders and investors alike. Knowing this information will help you make informed decisions when picking the one most important partner in your online trading Forex career — your Forex broker.
Who are Forex Market Makers, and Why They Are, Well, Dangerous
Forex market makers essentially take the other side of your trade, every time you click Buy or Sell. For instance, if a Forex client buys one lot of EUR/USD at 1.12 and the client’s broker is market maker, they sell one lot of EUR/USD back to you at 1.12. In other words, market maker bets against the client. In a zero-sum game on global currency markets, only one side of the trade wins, and market maker is no different than a massive Forex casino that is so big, it can wait indefinitely until clients lose all money, Forex accounts drain all funds, and market making broker walks away with the profit.
Forex market makers will deploy a dealing desk that manages their exposure to profitable clients, using automated and manual methods to monitor all Forex trades that flow through their systems. Should a client start making money, and we are not talking here about a single lucky trade, but a consistent pattern of winning, such Forex broker may deploy extremely efficient tools that will intervene in trading execution processes, turning the bets in broker’s favor.
Straight Through Processing — STP Brokers and Direct Market Access (DMA) Approach
Unlike market makers, DMA/STP brokers don’t trade against their clients, but rather send every Forex trade to the interbank market. STP Forex brokers are interested in a prolonged relationship with the client since Forex broker’s own financial results are driven by commissions that their clients pay. Financial motivation that this approach creates generally means considerably better trading conditions, low Forex spreads and quick trade execution without any Broker manipulation.
In addition, the DMA/STP/ECN model makes expensive dealing desks irrelevant and unnecessary. This removes extra costs from the company’s financial structure and reduces expenses for Forex traders. Top STP brokers are interested in satisfaction of their clients and high customer retention rates. Thus, they tend to lower trading costs as much as possible and offer value-added services to assist their clients.
It is important to note that while both DMA and STP are business models, Forex ECN is a kind of technology that may or may not be used by STP brokers for best results. There is a slight difference between DMA and STP. While deployment of both business models will make your Forex broker send trades to interbank or other liquidity providers, STP brokers may add a slight mark-up on spreads that you see in your Forex trading platform. Combined usage of straight through processing approach and DMA pricing, on the other hand, provides online traders with true interbank quotes at all times for maximum transparency at absolute lowest trading cost. DMA and STP brokers will generally provide variable spreads and true market pricing that dependably reflects the state of interbank foreign currency markets.
In contrast to the above, a market maker is likely to offer fixed or “capped” spreads at certain limits. In comparison, an ECN or STP broker cannot and logically will not utilize such pricing model, since in doing so the firm automatically becomes a market maker, using its own risk-capital to create artificial demand for client trades. True STP brokers do not bet against their clients.
ECN Brokers and Electronic Communications Network Technology
ECNs generally include many liquidity providers (LPs). LPs simultaneously submit quotes to the ECN and the system aggregates Forex price quotes to show best bid-best offer, with minimum spread for each transaction. With true ECN, traders enjoy minimum spreads that often go down all the way to zero.
Both DMA and STP brokers maintain complex Forex liquidity networks that vary in their quality, size and diversity of trading partners. By diversifying their liquidity pools via ECN technology, DMA/STP brokers ensure that client trades are sent to liquidity providers and the global Forex interbank market, while paying these LPs a preagreed transaction fee, or commission. STP brokers arrange liquidity with various banking partners and institutional liquidity providers, creating a competitive environment on a single ECN Forex platform where various suppliers stream their best Bid and Ask prices, competing for the business of retail customers. ECN is a trading technology that powers up the price-matching engine of DMA brokers, selecting best prices for Forex traders at any given point in time in a highly efficient, streamlined automatic environment.
False STP/DMA Brokers and How to Spot Them
With STP/DMA/ECN Brokers gaining popularity among online currency traders, many companies nowadays misrepresent their offers and position the more common market-making trade execution as ECN platform. We will leave the judgment on the ethics of such misrepresentation, and instead emphasize red flags that will help Forex traders spot the lie and distinguish a true ECN broker from a market-maker.
1) True STP/ECN Forex broker will never offer you bonuses or no-deposit live accounts. Recall that STP brokers are in business of only matching your trades with real interbank liquidity for a commission. Only market makers who expect you to lose all funds will offer free money, while a live brokerage with global banking partners doesn’t engage in casino-like behaviors.
2) DMA brokers don’t want you to and don’t expect you to lose your money, so they will not employ predatory tactics, such as unreasonably high leverage, forced timeouts, price spikes, gaps, won’t forbid automated trading or scalping, and won’t resort to other limitations to stop you from effective trading.
3) STP brokers will not promise you easy millions or offer freebies, such as free education, trading signals or falsely-profitable expert advisors, all of which are completely worthless anyway. True STP/DMA/ECN brokers will invest in their technology and cater to experienced, professional Forex traders who already know the differences in broker business models and can spot the rotten apple.
Recommendations for Professional Forex Traders
Forex brokers are in the midst of a revolution. Direct Market Access, Straight Through Processing, and Electronic Communications Networks are making an extraordinary impact on broker operations, lowering transactional costs for Forex traders and drastically improving performance of trading systems. Combining the best in trading technology and interbank Forex liquidity, the 100% DMA/STP/ECN business model is a no-brainer when it comes to selecting your Forex broker.
Concord Bay offers a true 100% DMA/STP/ECN platform to both large institutional investors, other Forex brokers and smaller retail clients. The firm aggregation technology matches liquidity from 50+ tier-one banks and institutional providers, offering lightning fast execution of 3 ms or less, spreads as low as 0.0 pips, amid full broker transparency and with full commitment of a true agency model. Concord Bay clients are free from traditional broker pressure or manipulation. Here is basic information every trader needs to know:
DMA Advantages to Traders, and Why Concord Bay stands out in the crowd:
1) There are no discriminatory rules or predatory practices against any trading system or style. Broker and trader interests are aligned. Every trading system is welcome, including high-frequency trading and automated expert advisors, news trading and scalping.
2) Concord Bay offers requote-free environment.
3) No price manipulation, and no spread mark-up — only true interbank quotes at all times.
4) DMA broker works for the client and not against the trader. Conflict of interest is finally out of the picture.