How do I choose a broker: ECN / STP or Market Maker?

ECN / STP (No Dealing Desk)

The acronym ECN stands for "Electronic Communication Network", it is used to show that a broker is connected to an electronic trading system where several liquidity providers offer competing buy and sell bids. STP denotes a Straight-Through-Processing model, which means that the broker does not intervene in the execution of orders, all trading is done automatically and electronically at the greatest possible speed and without any human intervention (No Dealing Desk - NDD). A market maker broker can also fall into the STP category if execution is carried out by software and not manually by the broker.

Brokers that directly send all of their orders to one or more liquidity providers with the "A booking" system do not bear clients' risks internally, they simply act as an intermediary between clients and liquidity providers. These brokers make money off of the trading volume via a commission on each trade or a spread markup. It is therefore in their interest that their customers earn money as long as possible, as they can continue to earn brokerage commissions. This is why most traders believe that ECN/STP brokers are more reliable and cost-effective for them.

In reality, statistics of brokers regulated by the NFA in the USA show that traders who use ECN/STP brokers also often lose their money. The marketing argument which claims that ECN/STP brokers are more reliable because they don't make money off of their clients' losses is therefore unfounded.

Unregulated offshore companies have lost the trust of traders, who more readily choose to trade with regulated brokers in a reliable and recognised jurisdiction. The ECN/STP model is therefore beneficial for brokers because the cost to obtain a license in a "serious" jurisdiction (example: United Kingdom) is lower than for a Market Maker licence and the regulation is less restrictive.

 

Market Maker (Dealing Desk)

Unlike an ECN/STP broker, a Market Maker does not always cover its clients' positions with liquidity providers, so it is obliged to pay its clients' winning trades using its own money or the money of its losing clients, in other words its clients' profits are losses for the broker. These brokers use a "B-book". This model carries greater risk for the broker, but statistics show that the majority of clients lose their money. In general, the income of MM brokers is higher than that of ECN/STP brokers who have the same trading volumes.

MM brokers bear a higher risk compared to ECN/STP/NDD brokers, however, during the sudden SNB (Swiss National Bank) crash, the brokers that suffered the greatest losses were brokers with an STP / No Dealing Desk model. (Read our article: CHF crisis: DD brokers resisted better than NDD brokers)

Brokers who wish to obtain a MM broker's license in a recognised non-offshore jurisdiction need to make a large deposit (from 100K to 1 million depending on the jurisdiction), and they must also submit regular reports to the regulator.

It is also worth mentioning that some offshore MM brokers do not have any licenses. That's why these brokers use a MM model for offshore countries while creating another brokerage with an ECN/STP license in a recognised jurisdiction in order to earn the trust of customers. Using this scheme, the offshore market maker broker acts as a liquidity provider for the ECN/STP brand. This allows an ECN/STP broker to display a license issued by a respectable regulator while in reality it is actually an offshore market maker broker that is subjected to minimal costs.

 

Hybrid model

Many brokers mix these models and only transmit some of their clients' orders to an A-Book, while the orders of other clients (the losers) are sent to a B-book. This system can vary: some brokers will choose on their own which orders are actually executed on the market without this being noticeable by the clients; others offer separate offers: entirely ECN/STP accounts (no dealing desk) and accounts with MM execution (dealing desk).

 

NDD or DD trading platforms

 

Conclusion

In both cases (ECN/STP/NDD or MM/DD broker), perfectly reliable brokers exist, just choose a broker that is located and regulated in a country with strict regulations, such as the United Kingdom (FCA regulation). The most important thing is to choose a broker that offers a guarantee on your deposits and good trading conditions. The main risk doesn't come from the NDD or DD broker but from you, you control the risks you take whe you trade! Brokers have strategies to manage their risk and to earn money with all types of clients, whether they are profitable or lose money.

The guarantee on deposits in the event of a broker bankruptcy varies according to regulations, for example, it is 20,000 euros if your broker is regulated by the CySec in Cyprus (ICF - Investors Compensation Fund) or 50,000 if the broker is regulated in the UK by the FCA. However, such compensation is only for non-professionals investors. Some brokers even offer additional insurance for wealthy clients.

The term No Dealing Desk is often used by brokers as a marketing argument to suggest that Dealing Desk brokers make money off of their clients' losses. In reality, there aren't really any differences, because in both cases your orders always end up with a market maker (the liquidity provider) and statistics show that traders' performances are identical with the two types of brokers.

There is also another marketing argument which consists in saying that market makers create a synthetic market that allows an order to be processed even if there is little or no liquidity... and that with an ECN/STP broker, liquidity is not always sufficient for some currency pairs. In reality, all brokers sometimes have to execute orders with slippage or send re-quotes, because these orders are subject to the "Last Look" of a MM broker's liquidity providers or dealing desk. The Last look is a controversial practice that allows market makers to have a last look at their clients' trading orders in order to delay or reject them. (See our article: Debate on "Last Look" on forex trading platforms). In general, brokers communicate very little on this subject.

It will be interesting to see the figures that brokers will present when MIFID II standards are in effect (on 3 January 2017). Brokers will be required to demonstrate evidence to prove that they are offering the best possible execution to their clients.

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