Brokerages offering FX trading services include those that operate on the STP, ECN, DMA, and other kinds of trading brokerage business models, among others. There is also the potential of a mixed (hybrid) technique that incorporates elements of each of the methods discussed so far. Customers’ trades are managed differently by various FX brokers, and the execution tactics used as well as whether or not they oppose orders and transactions might be useful data points.
If you need a plan of how to start a forex business, first of all, you should identify which model is suitable for you and your firm.
Brokerage Business Model Based On STP
For a variety of reasons, many traders still think that STP brokers are the best alternative. It’s interesting that they combine the features of ECN brokers and market makers. You should pay attention if you want to understand more about STP brokers and how they work since they operate in a very complex manner.
A straight-through processing mechanism is used by FX brokers to send orders directly to different liquidity providers on the interbank market in an inconspicuous way. A wide range of investors may be involved, including large banks, counter-party investors, large investment groups, and even hedge funds.
Since there are no trading desks involved, there are no intermediaries in the process. The absence of a middleman prevents order fulfillment delays and the need for requoting. To the advantage of the customer, this direct market access allows them to buy at the lowest possible prices.
Here, we come to an important question: how STP brokers generate money? The reason for this is because their liquidity provider (LP) bid/ask spreads will be augmented by a nominal margin. STP brokers provide spreads that change depending on the strength of the market’s bid and ask. The markup, on the other hand, is typically predetermined.
It is also possible to trade during financial news releases with STP brokers, but this is not possible with dealing-desk brokers. STP brokers are perfect for scalpers and news traders because of their lightning-fast execution of orders.
The level of anonymity and lack of potential for bias is higher in this setting. STP brokers aggregate buy and sell prices from a variety of liquidity sources and add the previously described nominal markup on top of them. An order is placed by the trader, which the brokerage then moves to one of their different LPs, retaining the profit from the spread difference.
First, the STP system prioritizes the buy/sell prices and then adds the markup. STP brokers will widen their spreads and boost their markups if a liquidity aggregator raises its spreads.
It’s not the brokerage that benefits from its customers’ losses; rather, investors are trading against other market participants, not the brokerage itself. It is true, however, that the opposite is true. Customers will cease placing fresh orders with an STP broker if they have lost too much money, and the broker will no longer be able to benefit continuously from the market.
ECN Business Brokerage Model
ECN seemed like a strange idea a few years ago. In fact, the idea was first regarded as implausible. This meant that only one Forex broker could be used for a basic trading platform. The MT4 ECN was established as a response to the needs of retail FX traders.
As a result, an ECN account allows traders to trade without the need of any middlemen. One of the benefits of using an ECN account is that trading orders are sent directly to the market and executed instantly.
In terms of the routing of liquidity, STP and ECN brokers are quite similar, but there is a major difference. Unlike an STP broker, an ECN Forex Broker or an ECN broker is a major figure in the marketplace.
Due to the broker’s representation of banks, hedge funds, and other key participants, it is virtually the primary source of liquidity. As a team, they are able to carry out commands that they would otherwise be incapable of carrying out alone.
When trading with an ECN broker, the minimum lot size is often much less than when dealing with an STP broker (the minimum lot size is 0.1). For beginners, this complicates trading since just a few liquidity providers enable them to trade with lower lot sizes, which in turn makes it more difficult for them to make money (from EUR 1000 to 2000).
The hybrid ECN+STP paradigm was created to address this issue.
DMA Broker Model
Direct Market Access allows FX brokers to trade on behalf of the customers. MMs at banks and other LPs quote prices for transactions to respond to consumer orders. DMA eliminates the need for intermediaries by routing all customer orders directly.
NDE non-dealing desk execution is confined to market price execution, which the traders may see. Some brokers provide quick execution to expedite order fulfillment and reduce risk. The brokers get the order and determine if they should use additional liquidity sources to complete it. The disadvantage is that the consumer may not be aware of it.
Variable spreads are more common than fixed spreads among DMA brokers. Depending on the deal execution platform, DMA FX brokers often levy an additional fee or impose a fixed markup on customer transactions.
Most ECN FX brokers also provide DMA. Some STP FX brokers do not provide DMA to their customers.
A Hybrid Approach Of Business Brokerage Models
Some FX brokers may use one or more of the approaches outlined above to handle customer transactions. A benefit of using many brokerage business models in one strategy is that the dealer may choose the one that works best for them.
In order to perform an entirely electronic FX trading service, the ECN or DMA and STP techniques are often used. The order input procedure may now be completely automated to handle spread pricing and execution, enabling brokers to concentrate on other activities. In order to save money, brokers may use a hybrid architecture that combines an ECN or DMA with STP, yet still, maintain a competitive transaction execution service.
Brokerage Business Model of the Market Maker
Trading desk deals are charged a spread by the FX brokerages (DD). Market makers aim to profit as much as possible from the spread. Fixed trading spreads and two-sided market pricing should be offered by their broker.
It is typical practice for FX firms to use market makers since retail traders are more likely to lose than profit. Market makers tend to extend their spreads when the market is volatile. If customers are still undecided, the market maker may offer a different price. Transaction rates tend to be steady for a short period of time as long as the client’s breath is hot.
Market makers may modify their stated exchange rates above or below the genuine market rate depending on their market perspective and current inventory condition. You must keep this in mind. The effect is that market makers may lower costs when the customer sells and increase them when they purchase.
Stop-loss orders may be triggered by market makers “spread popping” when they shift their spread. Traders at financial institutions may fill a stop loss order with their own trades at a discount in order to profit from it. Traders may choose to postpone order execution or trade ahead of and around orders to profit from them more.
Every time there’s a transaction, traders are always on the other side. MMs require customers that are both buyers and sellers in order to continue in business. The consequence may be a stalemate between market makers and customers.
The price transparency of a market-making broker is often lower than that of a broker that uses wire transfers. Market makers may be asked to assist in deciding whether to hold or offset the contract after it has been signed.
The MTF Brokerage Model
Some online FX brokers are using a broker model similar to that used by authorized financial exchanges, even though they don’t have such status. These brokers are referred to as Multilateral Trading Facilities (MTFs) under EU MiFID laws. Alternative Trading Systems, on the other hand, may be used to describe them.
To put it simply, an MTF is an investment firm that connects buyers and sellers to form contracts. They must adhere to a set of regulations dictated by the system’s internal operating procedures.
Choose The Right Brokerage Business Model
The ultimate choice is yours, but it’s important to think about the audience you’re trying to attract before making a final selection. An awareness of the risks and costs associated with each option you pick will help you make a more informed decision on where to locate your business.