Understanding Different Types Of Brokers: ECN, STP, ECN+STP
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This article will outline the differences between ECN brokers, STP Brokers, and the Hybrid Model (a combination of ECN and STP). It will help traders to understand the different types of brokers available, by comparing differences such as how they process orders, the lot sizes they allow, whether they require dealing desks or not, and much more!
Unfortunately, many people wrongfully associate Forex (FX) trading with scams. The problem lies in the increasing number of unscrupulous companies marketing false information to traders. The number of Forex-related scams has significantly increased over the past few years, so it's important for you to be able to identify a hoax. After all, Forex trading should be a potentially profitable experience.
When choosing a broker, always check if they are regulated by a relevant authority first. Simply put, if a broker is not regulated, your money is not safe. Every broker should abide by the rules of a financial authority. In the context of defending citizens from fraud, many countries have established private or state organisations to regulate the Forex market. Generally speaking, these organisations are actively supported by the government.
The top three countries with the most rigorous regulators are:
- The U.S. CFTC and NFA (Commodity Futures Trading Commission and National Futures Association
- Japan FSA (Financial Services Agency)
- The UK FCA (Financial Conduct Authority)
Choosing a broker is the very first step you need to take to be able to enjoy your trading experience. But many people don't know the differences that exist within the range of fully regulated brokers.
Types of Brokers
We can distinguish between several types of Forex brokers according to a range of criteria. Usually Forex brokers can be divided into groups for:
- Brokers with licences (reputable)
- Brokers without licences (or non-reputable brokers)
Depending on the execution of orders, there are:
- Dealing Desk Forex brokers
- No Dealing Desk Forex brokers (STP or ECN)
Depending on the trading platforms on the exchange rate, we can have:
- MT4 Forex brokers
- MT5 Forex brokers
- Brokers with a proprietary platform
- MT4 & MT5 brokers
Generally speaking, there are DD (Dealing Desk) and NDD (No Dealing Desk) brokers. NDD brokers include:
- STP ( Straight Through Processing)
- ECN (Electronic Communication Network)
- Hybrid (ECN+STP).
We usually refer to DD brokers as market makers. The infamous term "market makers" is used because these brokers usually take the opposite side of traders' trades. They make money through spreads and by providing liquidity. They also try to find a matching long or short order from their other clients, before taking a countertrade or passing it on to a liquidity provider. They are known to offer artificial quotes, and orders are filled on a discretionary basis.
No Dealing Desk
Contrary to DD brokers, NDD brokers use both the STP and ECN technologies without a dealing desk, and route trade orders directly to liquidity providers. This allows clients to access real markets with better and faster fills. It is a bridge between clients and liquidity providers, and there are no requotes when an order needs to be filled. We differentiate between two types of NDD brokers: the STP and the ECN.
The STP (or Straight Through Processing) technology requires no dealing desk. All orders are routed to the broker's liquidity providers, and prices are executed at the bid/ask rate provided by liquidity providers. Liquidity providers in this case are hedge funds, big banks, and investors that effectively act as counterparties to each trade. Usually, the STP broker has an internal liquidity pool that is represented by different liquidity providers, that compete for the best bid/ask spreads for STP broker orders.
In a broader sense, STP means that the broker company plays the role of a silent connection provider between the market and the trader, rather than a dealing desk re-processing trades. Please note that Admiral Markets uses the STP model exclusively. The other benefit of an STP broker includes the 'DMA'. DMA stands for Direct Market Access. DMA refers to when a broker is passing their client orders directly to their liquidity pool, so orders are filled at the best possible price, with only a small mark-up spread by the broker.
You should always aim for the broker with the most variable spreads. The reason for this is that the broker with the most variable spreads is able to select the best bid from one of the liquidity providers from their own pool, and the best ask spread from another liquidity provider. That effectively offers the best possible spread for their clients. The STP execution simply goes without any requotes, and due to its lightning speed, it is very suitable for traders who like to scalp and trade the news.
A few years ago, the MT4 ECN seemed excessive. In fact, the initial reaction to this concept was that it seemed like something impossible. If a Forex trader wanted to use the standard platform, they were supposed to trade solely with one broker. Nevertheless, the demands of the retail Forex trader ultimately became heard, and MT4 ECN was developed as a response.
There are a lot of similarities between STP and ECN brokers, but the primary difference is routing. As mentioned above, the STP can choose to deal with different liquidity providers out of their liquidity pool, while the ECN acts as a form of hub. The hub acts effectively as the major liquidity source, as it is represented by banks, hedge funds, and all the major market players.
They all become interconnected in order to find counterparties for the orders they are unable to handle internally. Another difference between the STP and the ECN is that ECN trading is mostly capped at a 0.1 minimum lot size. This is because there are very few liquidity providers allowing for less than 0.1 lots, which proves to be difficult for inexperienced traders who need to trade with smaller amounts of money (for instance, between 1000-2000 EUR), so a hybrid model has been developed as a solution.
The Hybrid model is a combination of both the ECN and the STP. Usually, with this type of service, brokers are able to focus on providing great customer service, education, and different market analyses. Blending the ECN and STP models allows for a fully electronic Forex dealing service. This popular mix allows a Forex broker to fully automate the order entry, dealing with spread pricing and the trade execution aspects of their deal execution business.
Possibly the best model is the STP, although the hybrid model through NDD is also an excellent choice. Applying the STP and the ECN models, brokers avoid market making. It is a win-win situation for traders and brokers alike. Brokers don't want traders to lose, because they might earn more from spread or a commission, the longer that traders are using them.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.