Difference Between ECN and STP
December 28, 2016
Forex brokers are either market makers or pass trades to liquidity providers. A true brokerage house with no conflict of interests should one that fits in the second category. STP and ECN brokers are fitting in this category.
Before discussing the difference between STP (Straight Through Processing) and ECN (Electronic Communication Network), it is important to understand what market makers are.
A market maker is effectively creating a market for its customers and takes the opposite side of their trades. Every winning trade a trader has, represents a loss for the market maker broker.
Such brokers are called dealing desks as they are somehow an artificial type of broker as the market is not reflected directly, only prices being quoted. For the reasons mentioned above, a market maker is being viewed by forex traders as having a major conflict of interest with its clients.
ECN (Electronic Communication Network)
A true ECN broker is the true broker that let traders access the interbank market. With such a broker, traders have access to the market and they can see the actual prices displayed in the market.
The other parties that can take the other side of the trade are other brokers, banks, financial institutions, all in all, everyone having an interest in markets. The biggest drawdown for this type of broker is that fills are not guaranteed, especially when trading with pending orders ahead of an important economic release.
For example, if you have a pending order to buy from higher levels (a pending buy stop) and market travels due to an economic release, chances are the order will be filled at higher levels than the desired one. Depending on the trading strategy, this may make the difference between a winning and a losing one.
However, it is the true form of brokerage and these days some forex brokers found a solution to offer retail traders access to ECN conditions. The problem was that smallest lot possible was at such an elevated level that many retail traders simply couldn’t afford such a trading account. This seems to have changed lately, though.
Straight Through Processing (STP)
An STP broker is passing all or some of the trades to liquidity providers for execution. While this is ok, as trades are basically routed to the market, a trader is not knowing exactly if the broker is the only STP or it is a market maker as well.
Sometimes brokers are splitting traders into different categories based on their trading behavior and type of the trading account they opt for. If the broker considers the trader has a winning potential, it will handle his/her trades through the STP servers, if not, through the market maker ones.
It is obvious that conflict of interest is not present if the broker is routing all the trades through the liquidity providers, but if this is valid only randomly, it will result in slow execution and a lot of re-quotes.