Types of Retail Forex Brokers: ECN vs DMA vs STP vs Market Maker

DD/MM(Market Maker, brokers that have dealing desks)

DD/MM Dealing Desk Brokers ( or Market Maker):

  • Act as a counterparty for client transactions
    • Route orders through Dealing Desks
    • Make the market” and trade against clients. (They take the opposite side of the trade. When traders want to sell, they buy from them, when traders want to buy, they sell to them)
    • Dealing desk brokers are able to profile their clients.  They divide clients into groups systematically with algorithm. (Usually called “A Book”, “B Book”)
      • “A Book” Automation for losing clients: Broker automatically take the other side. Losing trades of clients are counter-traded and become brokers’ profit. More losing traders means more profit for the broker.
      • “B Book” Automation for winning clients: Broker automatically take the other side and then hedge the position in the real market that they have access to. (e.g. When traders buy , broker sell to them, then the broker buy the same amount in real market). This is also done automatically through algorithm. In this case,  brokers will also make money (through  spread or commission).
  • Fixed spreads
  • Makes money through spreads and when a client loses a trade.
  • Price Manipulation is possible. Traders can’t see the real market quotes.
  • Transparency of dealing desk brokers differ depending on their own company rules.

NDD(No Dealing Desk)  Forex Brokers

  • Act as an intermediary
    • No dealing desk = No market making = Straight-through processing
    • Straight-through processing enables the trade process to be conducted electronically without manual intervention
    • Providing access to the interbank market without dealing desk. All orders are passed to Liquidity Providers(LP) directly.
  • No re-quotes and no additional pausing when confirming orders.
  • Makes money by commission or spreads
  • In the retail fx markets usually there are 2 type of NDD forex brokers:  Regular STP Forex Brokers & ECN Forex Brokers.

Benefits of No Dealing Desk brokers

  • Anonymity. Clients’ orders are executed automatically, immediately and anonymously. There is no dealing desk watching you orders.
  • Better&Faster fills. Because all Participants or liquidity providers compete for prices in a real market.
  • Transparency.

Liquidity providers (LPs)

  • Liquidity providers act as ‘supplier’ for forex brokers. Both LPs & forex brokers need to make money.
  • With NDD Forex Brokers, LP(s) are the counterparty to you trades. They take the opposite side of your position, and looking to make money by closing this position later in a trade with another party.
  • Prices are determined by LP(s)
    • LPs compete for providing the best bid/ask rates for orders from brokers.
    • More LPs usually means more depth in the liquidty pool,thus better spreads.
    • Traders usually get variable spreads.
  • Number of Liquidity providers
    • One Liquidity Provider.  Some so-called ‘STP’ brokers have only one LP, so there will be no price competition, their role in fact are just  IB (Introduing Broker). LP control the price(spread). Maintenance costs is lower, but the broker become completely dependent on the one LP.
    • Most STP Brokers has a predetermined number of liquidity providers.
    • ECN brokers have a large number of liquidity providers.

STP Forex Brokers

  • STP Forex Brokers don’t trade against clients
  • Make money through spreads mark-ups. They add small mark-ups on the best bid and ask rates they get from LPs. For example, adding a pip to the best bid price or subtracting a 0.6pip to the best ask price of their LPs
  • No dealing desk & No dealer intervention. Clients’ orders are directly sent to a certain number of liquidity providers (Banks or Other Brokers)
  • More liquidity providers means more liquidity and better fills for the clients.
  • Provide access to the real-time market quotes
  • Those STP Brokers that have fixed spreads won’t adjust spreads based on the lowest bid/ask prices offered by LPs. The fixed spreads they charge are higher than the best quotes they get from LPs. They may use their back-office price matching system to make sure they can make profits on spread difference while hedging the trades with LP(s) at better rates at the same time.

Direct Market Access

Forex DMA refers to electronic facilities that match orders from traders with bank market maker prices. It enables buy-side traders to trade in a transparent, low latency environment.

  • Direct access to the market. All orders are passed to LPs directly
  • Trader can place orders with LPs( banks, market makers, other brokers  etc).
  • Only Market execution. STP brokers that offer Market execution provide true Direct Market Access (DMA)
    • Market execution is more transparent. Orders go to the market,and are filled based on available quotes from LPs.(STP+DMA brokers will add a small mark-up in order to make profit)
    • Instant execution is less transparent. Orders don’t go to the market. They are instantly filled by the broker, who then may (or may not) offset own risks with LPs. Some STP Forex brokers fill clients’ orders though Instant execution,after which they hedge these orders with their LPs in order to make profits. If there are no profitable hedging opportunities when traders submit their orders,they may experience re-quotes.
  • Orders are facilitated by brokers. The broker is not a market maker or liquidity destination on the DMA platform it provides to clients.
  • Platforms build a fixed mark up into the client’s dealing price and/or charge a commission.
  • Only variable spreads
  • optional: Depth of the market book access (DOM access)
  • ECN forex brokers always offer DMA, some STP brokers offer DMA

STP Forex Brokers that offer DMA:  

List of STP+DMA brokers  http://fx-c.com/dma/

STP+DMA Benefit

  • Anonymous platforms ensure neutral prices reflecting global FX market conditions.
  • There are no re-quotes, rate rejections or partial fills with the DMA model because their liquidity providers are committed to their bid/ask offers
  • Competitive prices
  • Transparency
  • Welcome all trading style

STP vs STP with DMA

  • STP+DMA brokers have more liquidity providers thus better prices for clients.
  • STP+DMA brokers always offer variable spreads,some STP Forex brokers offer fixed spreads
  • DMA order execution is always Market execution;
  • There are no re-quotes with the DMA model
  • DMA model allow all trading style:scalping,news trading, swing trading,position trading etc.

List of STP brokers http://fx-c.com/stp/

ECN Forex Brokers (ECN=Electronic Communications Network)

List of ECN Forex brokers: http://fx-c.com/ecn/ List of Metatrader ECN Forex brokers: http://fx-c.com/mt4-ecn/

ECN Brokers

  • ECN brokers pass your trades to an ECN pool, in which other liquidity providers(banks, hedge funds, brokers, individual traders) become a counterparty to your trade.
  • All participants (banks, market makers and retail traders) trade against each other by sending competing bids and offers into the system.
  • Allow clients’ orders to interact with each other.
  • Orders are matched between counter parties in real time.
  • Participants get the best offers for their trades available at the time.
  • Only variable spreads
  • Makes money only through commission. ECN brokers do not make money on spreads(bid/ask difference).
  • Display the Depth of the Market (DOM) in a data window. Traders can show their order size and other traders can hit those orders. Then can see where the liquidity is.

ECN Benefit

  • Anonymous trading environment.
  • Straight through processing with banks liquidity.
  • All trading styles are welcome
  • Interbanks prices and spreads. Greater number of marketplace participants means tighter spreads.
  • Greater price transparency, faster processing, increased liquidity.

ECN vs STP Brokers with DMA

  • ECN is the most transparent model. ECN Forex broker provides a marketplace where all its participants trade against each other real time.
  • Both offer only variable spreads;
  • STP+DMA Brokers will also add a small mark-up to make profit. ECN Brokers charge commission.
  • Both have fractional pricing;
  • Both have DOM (Depth of the Market) orders book. STP+DMA Brokers usually don’t show it to you.

Hybrid Model

  • Many brokers offer dealing desk account, ECN account or STP Account at the same time. Traders can choose the one they like.
  • Cents Account or Mini Account of a STP broker is usually the account that has a dealing desk. All small orders by traders (usually below 0.1 lot) can’t be sent to the liquidity providers, because they don’t accept small orders based on the contract they have with the forex broker.So they usually use dealing desk model for this type of account. .
  • Usually for orders above 0.1 lot, STP brokers send orders directly to it’s liquidity providers with STP Model.

Conclusion

  • Dealing desk brokers or Market makers make money on spreads and when clients lose trades.  More winning traders will increase the operational risk of a dealing desk broker.
  • No dealing desks brokers are more transparent. They want their clients to win because clients’ losses are not their profit,and the more clients trade, the more profit for them(through commission or small spread mark-up).
  • Not all forex brokers will be honest with you,so whether you choose ECN , STP, or market maker,it’s important to trade with the broker that has a good reputation.

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One thought on “Types of Retail Forex Brokers: ECN vs DMA vs STP vs Market Maker

  1. Alex McCullie says:

    Thanks, appears to be an excellent summary of issues i only vaguely understood. Important to know who is doing what out there in the world of brokers.