when deciding which route to choose.
Most Forex brokers usually operate under the STP, ECN and DMA broker models, although some may use a hybrid of two or more. When making a comparison between Forex brokers, you can make a judgement by looking at the way in which they execute customer transactions and whether or not they take the other side of the order and transaction that is passed through them.
It is worth getting an understanding on how each of these models works so that you can select the best order execution method for your Forex brokerage business.
ECN Forex Broker Model
Forex brokerages that use an Electronic Communication Network (ECN) model provide their clients with a direct way to access the Interbank Forex market for pricing & execution which takes place through an ECN trading platform.
Using the ECN execution model for their clients’ transactions, a broker effectively has a No Dealing Desk (NDD) positioning as they are operating as a middleman between their clients and the greater currency market. By choosing to deal through an NDD Forex broker, a trader cuts out both the market maker and their dealing desk who are likely to profit from their transactions.
Most ECN brokers display order information and exchange rates in real time as they fluctuate, and their pricing on transactions comes directly from the Interbank Forex market. As trades are handled electronically, ECN brokers tend to have a reduced human error rate.
One of the main advantages in dealing with this kind of brokerage is that the risk of re-quotes is virtually eliminated. This can really be a considerable benefit to news traders who like to benefit from high market volatility surrounding major economic data releases such as the NFP. A further advantage is that ECN brokers also allow traders to deal on spreads that can be substantially tighter than that quoted by a single market maker.
Some brokers that use the ECN model charge a flat execution fee on a per-trade basis as a commission, which is of benefit to those who usually trade larger amounts but less frequently.
Alternatively, there are some ECN brokers who widen the trading spread so that their client can deal on and charge fees in proportion to the amount dealt on each trade. This kind of ECN broker may be better suited to traders who have a preference for trading frequently but in smaller amounts.
STP Forex Broker Model
Forex brokers who use a Straight Through Processing (STP) model usually have a fully automated dealing system for their clients’ use. Since they don’t operate a dealing desk, they are known as a NDD or No Dealing Desk broker. This broker model is also often referred to as the A-Book forex brokerage model.
The STP system works by processing each trade electronically and entering them directly and anonymously into a group of Interbank Forex market participants i.e. liquidity providers for executing at competitive prices.
The stand out advantage of using an STP broker is that no human related errors, delays or costs are associated with transactions since traders avoid having other people intervene in their deals.
Another good reason to use an STP broker is greater liquidity as prices are acquired from a number of market participants instead of from just one liquidity provider. This results in better fills, tighter dealing spreads and more accurate quotes when compared with the service provided by a Forex broker which only has a single source for its quotations.
DMA Forex Broker Model
Forex brokers sometimes use a Direct Market Access (DMA) model to execute their clients’ transactions. This automated service works by matching client orders with dealing prices offered by market makers or other leading liquidity providers. With the DMA model, all client orders get passed straight to liquidity providers.
DMA involves non-dealing desk (NDD) execution at the market price only, making it a more transparent procedure from the trader’s viewpoint. By contrast, the instant execution services offered by some brokers tend to involve the broker filling the order on their own and then making a decision regarding whether or not to offset the risk with other liquidity providers. This is less transparent to the client.
DMA brokers typically offer only variable spreads to their clients as opposed to a fixed dealing spread. Additionally, the deal execution platform provided by DMA brokers usually adds a fixed mark up to client transactions or charges a per-trade commission.
ECN brokers sometimes offer a DMA service to their clients. While some STP brokers also offer a DMA service to their clients, this is not always the case.
Hybrid Forex Broker Models
Some Forex brokers opt for a hybrid model for client transactions with a combination of the aforementioned models. This can be beneficial to the trader if they think a combination of models is better for their trading strategy.
An typically common hybrid involves a combination of the ECN or DMA and STP models to create a completely electronic Forex dealing service. This concept enables a broker to automate the order entry fully to deal with spread pricing and execution aspects of their business. Using an ECN or DMA and STP hybrid model generally allows a broker to lower their costs somewhat after system development completion which means they can offer a discounted deal execution service.
Choosing the Best Forex Broker Model There are therefore many considerations to take into account when choosing the best type of online Forex broker for your needs, each kind offering different advantages. Overall, deciding on the most suitable Forex broker for your trading needs typically depends on the kind of trading strategy you prefer and the amount of trading capital you have available.