What are ECN, STP and NDD forex brokers?
When the forex market first became accessible to individual retail traders, the retail FX industry was dominated by
dealing desks who effectively took the opposite side of their own customers' trades (less lovingly referred to
as "bucketshops" after a similar business model in the early 20th century stock market.) The truth is that
even those dealers can offer decent conditions if they did so in a fair and transparent way, but the business model
obviously prompted a lot of suspicion. That situation wasn't helped by the fact that some industry members leaked documents
that exposed some of the manipulative and unethical practices often used at the time to sabotage customer profitability.
Naturally, the backlash came in the form of the "No Dealing Desk" or NDD generation of brokers. The basic
premise was the pass all trade exposure through to institutional liquidity providers (interbank forex market participants like
major banks or prime brokers.) Since the liquidity providers don't see each individual customer of the broker as a separate
trader and, in some cases, only get the net exposure of the broker, NDD brokers can eliminate the built-in
conflict of interest of dealing desks by not effectively taking the opposite side of customers' trades yet be compensated
in some way. NDD brokers generally come in one of two forms:
- the STP (Straight Through Processing) business model in which the broker simply widens the spread and passes trades
through to liquidity providers
- the ECN (an acronym from the stock market that actually stands for "electronic communications network") model
in which the broker offers the actual spreads from their liquidity providers and only charges a small commission
The choice between STP and ECN is typically a matter of taste and style for each individual forex trader. Some traders
prefer the better price action transparency of an ECN broker (choosing to see the bid and ask spreads of actual interbank
market participants rather than a padded spread) while accepting commissions separately. Others prefer the psychological
comfort of an STP model, knowing all profit and loss is built into the trade and never worrying about an external commission fee.
Either way, it worth keeping in mind that forex is a decentralized market. This means that even with a real ECN forex broker,
the actual raw pricing from liquidity providers will vary from other true ECN forex brokers. It depends on the quality and depth of
each broker's liquidity providers (the banks and prime brokers, institutional market participants, connected to the broker's ECN
system.)
The same issue applies to STP brokers since the padded spread is still derived from the raw pricing that the broker receives
from their liquidity providers.
What makes the best ECN Forex Broker?
Choosing the best ECN or STP broker isn't only about spreads. Sure, it's cost-effective for traders to look for decent average
spreads (and competitive commission, in the case of ECN brokers) but there's more to trading than just pricing. Always be sure to
look at whether the broker offers other features. Look for strengths and weaknesses that suit where you are as a trader - especially
when it comes to minimum account size, minimum size of each trade, software that suits your trading style or automated strategies, etc.
Regulated Forex Brokers
While it's often a good idea to look for some form of safety in the form of government regulation, keep in mind that this is only
an issue for safety of funds in terms of your balance. In reality, it's a good idea to make creative use of leverage so that it's not
necessary to keep all your trading capital deposited with your broker anyway.
For example, if a broker offers 1:100 leverage and your
strategy only really needs about 1:10 leverage, you can actually deposit 10% of your trading capital with the broker to support your
trades while keeping the rest in an insured, interest-bearing bank account to use only when you need it for drawdown periods.
Such strategies eliminate the need to risk your entire account on the broker's solvency while still being able to take advantage
of the strengths that the broker may offer.
More importantly, beyond regulation, the real test of the best forex broker for your needs is one that doesn't interfere with your
trading style. No regulator can overturn trades that may have turned from winners to losers because of the trading conditions offered
by the broker. Some of the most notorious bucketshops are technically regulated by the largest economies' regulatory organizations.
In those cases, their regulatory status could be used as a convenient distraction from their actual business model's conflict of interest
with their customers since regulation requirements rarely go beyond technicalities like capital requirements and politically-driven
bureaucracy.
On the other hand, if you're a large trader who deposits your entire risk capital with your broker, then it's definitely important
to look for a regulatory body that offers some sort of insurance on your balance in case of the broker's insolvency.
In short, it's always good to count regulation status in as one of the strengths of a broker (especially if you don't employ any kind
of creative use of leverage and actually deposit all of your risk capital at once) but don't hang onto it alone as a safety blanket.
Look at the broker's other features and make sure their offerings suit your needs and trading style first.
Finding the Best Forex Broker for You
It's always worth paying attention to a broker's business model, structure, and execution. You can always start off with a smaller
account to test out a broker's offering before you dive in. At whatever stage you may be in
your forex trading career, we hope our reviews will help you find the best fit for your needs.
