When trading with a FX and CFD brokers traders trade what is referred to as ‘OTC derivative’. What this means is that you are trading an instrument which is not traded on an exchange, you don’t own the actual stock, index or currency but are betting on it’s price and this instrument derives its value from something else (in this case the stocks, FX or indices which are traded on an exchange).
The broker with which you trade FX or Contracts For Difference (CFDs) can service you in three different ways. Keep in mind that sometimes they can do a mixture of more than one. The three options are: Market Maker (MM), Straight Through Processing (STP) and Electronic Communication Network (ECN).
Broker Review Contents
What are the advantages of a Market Maker (MM) broker?
Market Makers usually have lower requirements in terms of minimum deposit and trade size.
They are able to offer much tighter spreads than what the underlying market offers. Some of them can even offer spreads starting from 0 for FX.
This by default also means that you may be able to get better prices than what the underlying market has.
This means that the capital and costs are much lower when you trade with a market maker (MM).
What are the cons of a Market Maker (MM) broker?
As Market Makers (MM) by default take the other side of your trades, or in other words trade against you, this can raise questions about integrity or conflict of interest.
Another valid concern is that because the Market Maker (MM) is exposed to market movements, if its clients win big, it could lead to bankruptcy for the broker.
How to choose a Market Maker (MM) broker?
Consider only regulated brokers, because they keep their funds separate from client funds. Also client funds are usually held at top banks. This means that in case of default of the broker, the client funds should be safe as they are kept separate. Also considering brokers which are regulated in jurisdictions with a compensation scheme can boost the safety of your funds. Typically FCA regulated firms and EU brokers are backed by such compensation schemes. To further enhance this some brokers buy additional insurance for client funds which could cover up to 1 million in case of a default for the broker.
Most regulated Market Makers (MM) have the opportunity to Straight Through Process (STP) clients who are good traders, so concerns regarding manipulation of prices on individual account level shouldn’t be a concern. (LINK TO STP ARTICLE)
This means that choosing a regulated Market Maker (MM) broker could be one of the good options for both beginner and experienced traders.
What are the advantages of Straight Through Processing (STP) broker?
Traders are less concerned about conflict of interest as the Straight Through Processing (STP) broker doesn’t take the other side of your trades.
You can check a list with STP brokers here
Are there disadvantages to trading with Straight Through Processing (STP) broker?
They are limited to what their liquidity providers can offer. This could mean lower amount of symbols and markets.
It could also mean potential higher spreads, overnight costs and commissions because Straight Through Processing (STP) brokers base the prices which they offer on the ones which they receive from liquidity providers. In order for the STP broker to make money, it has to offer wider spreads than the one which it receives from the liquidity provider.
Your orders in the end most likely end up with a market maker anyway as most liquidity providers to STP brokers are market makers themselves. That being said, sometimes orders may reach the underlying market as well.
How to pick a Straight Through Processing (STP) broker?
As usual picking a regulated Straight Through Processing (STP) broker is important. This ensures that your trading funds are kept separate from the broker funds. Regulated Straight Through Processing (STP) brokers also keep client funds in top banks. Furthermore picking a regulation with a compensation scheme or a broker which has purchased insurance for client funds can further protect your capital.
Finding a broker which only does Straight Through Processing (STP) can be difficult. Keep in mind that many Market Makers (MM) also can do STP. Also many Market Makers (MM) have only one entity which owns a market maker license. For their other regulated entities they buy Straight Through Processing (STP) licenses, but they match traders from the STP entity with the Market Maker (MM) entity and essentially market make across all of their entities.
Therefore if you want to find a broker which only does Straight Through Processing (STP), it’s likely that they will only have one entity with a STP license.
What are the advantages of Electronic Communication Network (ECN) brokers?
Electronic Communication Network (ECN) gives you direct market access (DMA) and you can see liquidity and chose with whom to transact directly in the market. These can be other ECN traders, Banks or Market Makers.
Direct market access (DMA) means that you trade directly with liquidity providers and avoid the Straight Through Processing (STP) and Market Maker (MM) where the broker decides where to execute for you.
It means more integrity and no conflict of interest.
Check our list of Electronic Communication Network (ECN) brokers
What are the disadvantages of Electronic Communication Network (ECN) brokers?
High entry requirements in terms of capital. Most brokers ask for at least 10-15k USD.
You are subject to market conditions – this means you need to understand liquidity and the order ladder. If liquidity dries up, you may experience price gaps or may not be able to execute orders.
Many brokers claim to be Electronic Communication Network (ECN) brokers and technically speaking in terms of technology they are. However the fact is that a big amount of them list themselves as a liquidity provider and you still end up being matched with them. Thus make sure to find True ECN brokers, rather than ones which just claim to be but actually aren’t.