I get this question all the time: What is the difference between straight through processing (STP) and an ECN broker? Big difference.

Straight Through Processing from what I understand is just a name given to dealing desk brokers that have automated the dealing process. Traditionally in the spot forex market, when you place a trade, you are being filled by your forex broker also known as an RFED. This means the broker is the liquidity provider or “counter party” to your trade. They say this is good because when you need to buy, you will always have someone to buy from and vice versa if you have to sell. In a perfect world, what is supposed to happen next is the broker is supposed offset that position it opened counter to your trade with one of their liquidity providers, usually someone like UBS, and just pocket the difference which is the spread you pay.

That’s nice, but that is not reality. When your disclosure document describes this “counter party” process, it usually mentions something about a “conflict of interest”. What this means is since the broker wins when you lose, it is not in their best interest for you to win. Sound familiar? See Las Vegas.

Now, this brings us back to STP. So some brokers attempt to dance around this counter party thing by describing their service as a “non dealing desk” service, or better yet a “direct market access” broker. This just means they got rid of the guys in front of the dealing computers, and hired robots instead. They have automated the dealing process. Why do you think there are so many dealers looking for jobs right now? So the conflict of interest is still there. It is not in their best interest for you to win. Go to nfa.futures.org and look up some of your favorite forex brokerage houses and read the regulatory actions taken against them.

In my opinion, the dealing model is flawed because very active traders, the ones that dealers need to continue paying their bills, eventually realize that the costs are too prohibitive. So they go somewhere else. Now if you are a swing trader, then none of this really matters, because you are not facing the steep costs generated by the spreads since you are trading much less frequently. If you win too much, they simply offset your trades to their liquidity providers.

So where do the more active traders go? The ones who trade often and with size? They go to the ECN brokers. ECN stands for Electronic Communications Network. They became popular in the equities market over 10 years ago. They are just networks that match buyers and sellers. In the case of spot forex, if you trade on an ECN, it could be a bank on the other side of your trade, or another trader like yourself.

ECN’s are more natural markets since there is no one dealer in control of the quotes. The advantages to trading on an ECN is you can actually bid and offer your positions, and the spreads are usually around half of a pip. One disadvantage is you are paying a commission which can really add up if you trade too small and too frequently.

When trading spot forex, it is important to know what strategies make the most sense within the type of market process you are dealing with. Brokers in the spot forex market are not scalper friendly and are motivated to prevent scalpers from operating. On the other hand, swing trading is a much better strategy for trading with these types of brokers because they can easily hedge themselves against such traders if they have to.

So now you know the difference between STP and ECN brokers. The big question now is: do you know what type of trader you are? Your answer will help you choose the broker that is best for you.

—
Marc Principato, CMT
Director of SMB Forex Trading And Education

SMB Capital
One State Street, 10th Fl
NY, NY 10004

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