WHAT’S THE DIFFERENCE BETWEEN A STP AND AN ECN FOREX BROKER?
Is your retail broker a DD or NDD broker?
If NDD, are they a STP or ECN broker?
Do you know the difference?
Let’s look at the difference between DD and NDD forex brokers and clear up any confusion between the STP, ECN and hybrid execution models. This information will help you understand what type of brokers are available for retail forex trading and how the platform your broker uses affects things like how they process orders, the lot sizes they allow, access to markets and conflicts of interest that might arise.
What types of retail brokers do you get?
Forex brokers are typically divided into the following groups:
Brokers who are licensed and regulated by a top-tier authority
Brokers who are not licensed nor regulated
Brokers with a proprietary platform
Brokers who offer a combination of MetaTrader, other popular platforms and/or a proprietory platform
Execution of orders
Dealing Desk (DD) forex brokers
No Dealing Desk (NDD) forex brokers
Hybrids (combination of DD and NDD)
No dealing desk (NDD)
Straight Through Processing (STD) forex brokers
Electronic Communication Network (ECN) forex brokers
Hybrid (STP and ECN)
Dealing Desk (DD) versus No Dealing Desk (NDD) forex brokers
What is a DD broker?
Dealing desks are used by large banks and finance institutions to execute trades in securities and other financial instruments. In the forex market, a dealing desk is where forex dealers working for a traditional bank or hedge fund are seated and execute forex trading orders for the company.
DD brokers are also known as ‘market makers’. They typically take the opposite side of forex traders’ positions and make money through spreads and by providing liquidity for clients.
DD brokers will match long and short orders passed on to them by forex brokers and then they’ll take a countertrade or pass it on to a liquidity provider. Basically, DD brokers offer artificial quotes and orders which are filled on an option-to-use basis.
What is a NDD broker?
NDD brokers use technology that bypasses a dealing desk and sends trade orders directly to their pool of liquidity providers. This means they can offer their clients direct access to real markets with better pricing and faster fills.
Most of the world’s global liquidity is provided by large investment banks and hedge funds. They are referred to as Tier-1 liquidity providers and act as counterparties to each trade order executed. NDD forex brokers connect to investment banks or hedge funds in order to receive the bid and ask prices from their systems which are more stable than their own.
The NDD model means there are no re-quotes when an order needs to be filled which speeds up the trading process.
There are two types of NDD brokers: STD and ECN brokers.
What is a STP broker?
STP stands for Straight-Through-Processing.
STP is a post-execution, post-trade process between executing counterparties that has minimal impact on the speed and price of the order execution.
Basically, the STP model means the forex broker has no dealing desk. All orders are routed directly to the broker’s liquidity provider and prices are executed at the bid and ask rate provided by them.
A STP broker has an internal liquidity pool that is linked to several liquidity providers who compete for the best bid and ask spreads for retail forex brokers.
STP brokers act as the middleman between their clients and the liquidity providers and make money from the spreads. The benefit of the STP model is Direct Market Access (DMA). This means orders are filled at the best price because the brokers pass their clients’ orders directly to their liquidity pool and take only a small mark-up on the spread.
When considering using a STP broker, look for one that offers the most variable spreads. Brokers with the most variable spreads are able to select the best bid and ask spreads from their liquidity pool.
STP executions are quick and simple because there are no re-quotes. The STP model is popular among forex traders who scalp or trade on news because of the speed of processing and variable spreads offered.
What are the pros and cons of the STP forex model?
- orders are executed automatically and quickly
- traders get the correct price on currency pairs
- there are no re-quotes or clients can avoid quotes
- there is less risk involved with STP
- forex brokers can provide live market trends and news sources
- prices can change within seconds
- there is sometimes major conflict of interest between liquidity providers
What is an ECN broker?
ECN stands for Electronic Communication Network.
ECN is the anonymous communication between executing counterparties which may result in no guaranteed fills or pricing for the retail trader. Like STP brokers, ECN brokers do not direct trades to a dealing desk.
The main difference between a STP and an ECN forex broker is the way the orders are routed. STP brokers deal with an internal pool of liquidity brokers while ECN brokers acts as a liquidity hub.
This means the hub is the major liquidity source. It’s represented by large banks, hedge funds and other major financial institutions. ECN brokers connect with various liquidity providers to find counterparties for their clients’ orders which they’re not able to handle internally.
Another big difference is ECN trading is typically capped at a 0.1 minimum lot size. Very few liquidity providers off lot sizes less than 0.1 which means beginner traders who usually trade with smaller amounts of funds (1 000 to 2 000 EUR) will find it difficult to access orders.
This is where a hybrid model that is a STP and an ECN combo works well.
What are the pros and cons of the ECN forex model?
- traders offered better spreads from different sources
- higher liquidity
- direct market access
- ECN brokers cannot counter-trade against their clients
- there is no conflict of interest in pricing and executions
- trades are not identified on an ECN platform which means each transaction represents real market conditions
- there is no mark-up on spreads
- confirmation of executions are immediate
- traders pay higher fixed commission on every transaction
- traders need to make a large deposit to open an account with an ECN trader and start trading
- it is more difficult to calculate stop-loss levels with variable spreads
- the ECN platform is not as easy to use as the STP platform
What is the STP and ECN hybrid model?
Brokers who adopt the hybrid model offer a combination of STP and ECN executions. This model gives retail forex brokers an advantage where they can focus on providing the best customer service and the best price for bid and ask spreads.
The hybrid model offers forex traders the best of both worlds and allows them to offer their clients real-time access to a fully-fledged electronic forex dealing service. The order entry, spread pricing and trade execution is fully automated on the STP and ECN hybrid model.
STP or ECN forex brokers : Which one is best?
There are pros and cons to both STP and ECN platforms. Which type of forex broker you use depends on your level of experience, how much money you have to trade and your trading strategy.
STP is best for
A STP broker is best for beginner forex traders and new investors who have a restricted budget. STP brokers usually don’t charge anything to open an account and start trading and they take only a nominal mark-up on the spreads.
Trading with a STP broker is faster and easier. No commission is charged and there are no hidden costs to worry about, only the mark-up on the spreads. The only downfall is there is often a conflict of interest where STP brokers can trade against their clients.
It’s rare to find a true STP broker as most offer the hybrid model which is a combo of STP and ECN.
ECN is best for
A ECN broker is best for more experienced traders and investors who have a flexible budget and more trading funds. ECN brokers charge more to open an account and require a larger fund deposit you can start trading.
ECN brokers make money from commissions as well as spreads because ECN spreads are a lot narrower than STP spreads. The combo of commission and mark-up on spreads makes the ECN platform expensive for first-time forex traders. However, because an ECN broker consolidates price quotations to several liquidity provides, they usually offer tighter bid and ask spreads.
The ECN model is completely transparent and brokers do not trade against their clients. ECN brokers are pure NDD brokers which means they do not pass orders on to market makers (someone at the dealing desk). Instead, they match a trade electronically and only pass the orders to liquidity provides.
It’s rare to find a true ECN broker as most offer the hybrid model which is a combo of STP and ECN.
Straight Through Processing (STP) is a forex broker model where the broker sends client orders directly to the market without going through a dealing desk. The type of broker who uses the STP model is a No Dealing Desk (NDD) forex broker.
The STP platform is user-friendly and faster and cheaper than the ECN platform.
The ECN platform is a pure No Dealing Desk model that allows traders direct access to the markets in real time. ECN brokers also bypass the dealing desk and send their clients’ orders directly to the market through interbank exchange houses or liquidity providers. The ECN platform allows forex buyers and sellers to find a counterparty of their trading positions. This is where conflict of interest may arise.
There are advantages and disadvantages to the STP and ECN platforms. Which type of forex broker you use depends on your level of experience, forex trading budget and trading strategy.
FOREX TRADING AFRICA DISCLAIMER
Trading foreign currencies on margin carries a high level of risk and it may not be suitable for all traders and investors. Forex is a highly leveraged financial instrument and these high risk stakes can result in you losing money. Consider your appetite for risk before trading forex using a real live account.