During the last few years there has been a lot of discussion over the trading models applied in Forex market. One of the heavily advertised trading models is without any doubt the Straight through processing (sometimes misinterpreted as ECN). To understand STP as well as other trading models, one should first understand how the Forex markets functions in general.
Basically there are three main models and each broker can offer one or all of them – Market Maker, ECN and STP. The straight through processing model has numerous advantages for clients and that is why many brokers have applied it.
After you read this article please share with me your opinion of whether it was interesting and useful to you? How it contributed to your trading knowledge and do you agree with the views expressed?
Guest Post by Peter Traychev of Forexbrokerz
The anatomy of Forex Market
It is well known that the Forex market is the biggest, the largest of all, 24/7 round clock. But what’s behind the charts? Have you ever asked yourself this: when an order is placed where it goes? In other words, who is your counterparty for that particular deal?
In the regular stock exchange trading there is a great level of transparency because each trade has its clearly stated participants and parameters. Namely these are the buyer and the seller, the broker who made the contact between the parties being the participants and the quantity and value of the deal being the parameters of the deal. Each deal executed on the stock market is reported and recorded in a public record. It is called a regulated market because it has a set of rules such as the aforementioned.
In the Forex market some of those rules are not quite defined or completely missing and that it is why it is Over the Counter Market (OTC) or also called non-regulated market. We do not have a physical location where the trade execution takes place neither have we a record of the all the deals. We don’t know where our trade goes (in most of the cases). So does this really affect traders’ results in trading and what would be the trading model one should choose?
Market Maker
Those are brokers who play the role of your counterparty for each forex trade you make. If you buy EUR/USD they sell it to you and vice versa. In this sense you have opposite interest than your broker or usually it is stated that there is a conflict of interest between you and the broker. It is a widely spread misunderstanding that all client losses go directly into brokers pocket. The broker rather takes all its clients position and form a single net position which is then taken in or out of the pocket or hedged with other counterparty. If you think for a minute, you will find out that you are also a market maker because the position you open is at your own risk and you can take it in or out your pocket or decide to hedge it with another broker. There is no difference in how you and your broker manage the risk.
STP brokers
STP stands for Straight through processing. STP brokers simply places your order to the next counterparty which can be all of the three types of brokers: ECN, Market Maker or again STP. In this case the conflict of interest is eliminated and the broker just charges you the spread and additional commissions for the execution of the trade. What are the advantages of this model?
1. As stated above the conflict of interest does not exist anymore.
2. Anonymity – If you have a scalping trading style you can “hide” behind the STP broker and send all your orders to the next counterparty/counterparties without carrying about slippage and re-quotes. There is a possibility of receiving slippage and re-quotes after few weeks from your STP broker, because it gets it from its counterparty.
ECN Brokers
Those brokers try to mimic the stock exchange trading style by showing a full transparency of their trades and list all the counterparties in an order book. Like this you are able to see the best bid and ask offers and have the lowest spreads on the market. There are additional commissions applied but generally you can expect a cost of 0.7 pips per round turn trade on EUR/USD.
Final thoughts
All of the trading models have its pros and cons but the main and most important thing is the execution. If you get a fair execution and prices from your forex broker it hardly matters what trading model it applies.