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STP or Market Maker; Does it really matter? Are there more important things to know?

STPorMM

 

The two main business models used by Forex Brokers are the Straight Through Processing (STP) and Market Making (MM) models. In general, STP Brokers claim to transfer all their clients’ orders directly to their Liquidity Providers (LPs) and receive a small cut for doing so. On the other hand MM Brokers cover the orders internally with their own liquidity, and only cover high risk orders with external LPs. Using their own liquidity essentially means that they profit when clients lose money and lose when clients profit.

If you understand that then it should be clear that an STP broker should be neutral on whether or not their clients profit but they need their clients to trade in order to stay in business. On the other hand a MM broker typically will need their clients to lose overall in order to stay in business. By now you are thinking as a forex trader that it will be better to trade with an STP broker than with a MM and to some extent you would be right but it’s not as clear cut as that. Since the majority of traders lose overall a MM can afford to have a percentage of winning traders, and if they act responsibly the model works. Also, a MM with use internal liquidity so if there is mispricing or a technical error executing an order the broker can rectify the situation but an STP broker that covers clients’ positions with external liquidity doesn’t have that flexibility. However, there still is a conflict of interest with a MM broker, which at first it appears does not exist with STP brokers.

I am sure that you are wondering now how on earth the MM brokers are active in the Forex market and why they were not so affected when the STP model was introduced. There are 3 reasons behind this

    1. MM brokers market themselves towards clients that are likely to lose money. They do this by offering bonuses, training sessions and other similar things that newcomers look for. Those newcomers normally expect to lose money in order to gain experience so provided the MM provides that valuable experience it’s a win-win situation.
    2. MM brokers claim there is no middle man involved and you are trading directly with them, which is true. If anything goes wrong they can provide you full recourse.
    3. MM brokers also claim that even when you act as a STP Broker then you are transferring the orders to another LP that the latter acts as a MM. So in other words the MM brings direct liquidity to its clients.

How on earth will you know if your Broker is a true STP or a MM?

You don’t. However, there are ways to increase your chances to find out more about your Broker if is acting as a STP or not. How?

    1. Forex License: Regulated Forex Brokers they need to have either the STP license or the MM license. Normally, the capital requirements for the STP license is lower comparing to the MM license.
    2. Go through the client agreement before you register for a live account and the execution policy: Brokers that are licensed are obliged  to provide information about their LPs
    3. Try the Broker first with a small investment and see how it goes with your trading strategy first before you invest any serious amount. If you notice high slippage without any valid reason and when you contacted them about this they are blaming the Forex market then think twice before you move on to the next step.
    4. Read more about your Broker: Go through different websites and find out what was the experience of other Forex traders

If I noticed that a specific Broker is licensed only for STP does it mean that always my orders will be executed straight through to their LPs?

Not necessarily. Why? Because STP brokers may have an agreement with their LPs to receive a profit sharing out of their clients losses. Moreover, they may have sent their orders to their LPs however, the LPs can be owned by the same shareholders that own the STP Broker. So in a nutshell they transfer their orders to another Broker that is doing the Market Making.

So how can on earth can I select a Broker?

This is probably the million dollar question. You may come across a Broker that is a MM but the MM will decide to cover all your positions with different banks because they noticed that you are following a successful trading strategy. On the other hand, you may find an STP broker that is receiving a profit sharing deal from their liquidity provider based on the losses on your account. Therefore, they may ask you to leave when you realise that you are a profitable trader.  The bottom line is that it doesn’t really matter to you as a trader, which model your broker follows. What matters should be the quality of the execution, whether they are well regulated, that they provide you sufficient support services and ultimately that they can accommodate both traders that turn a profit and a loss.

Read 2291 times Last modified on Saturday, 22 December 2018 12:39
More in this category: How do Forex Brokers make money?

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