It is important that forex traders know what a market maker and ECN/STP brokerage system are. In these days of free Internet availability and high connectivity, most traders know how to choose a reliable and good broker.
ECN expands to Electronic Communications Network. An ECN broker is connected electronically by means of a network to international banks and other liquidity providers. If the forex traders trade via an ECN platform, it can be said that they are connected to the international currency market and are trading in real time. STP expands to Straight Through Processing. STP indicates that from placement of orders to closing the deals, everything is accomplished automatically without any kind of manual intervention.
On the other hand, if a trader opens an account with a market maker, they are essentially trading with the broker and not with the currency market. In such a scenario, if the trader makes a profit, the broker pays for it. If the trader loses money it goes into the broker’s pocket. Therefore, a trader’s profit is the broker’s loss and vice versa. It is known that many market maker brokers make their clients lose easily which works to their advantage.
However, many brokers who started off as market makers now claim to be ECN/STP brokers because of some changes that they brought about in their trading systems. Some of the so-called ECN/STP brokers can route your orders to another market maker broker who can make earning profits harder. It is therefore important for traders to be able to distinguish between ‘true’ and ‘false’ ECN/STP brokers prior to opening a trading account. Read on to find out how traders can differentiate between true and false ECN/STP brokers.
Differences Between True and False ECN/STP Brokers
It is not very difficult to differentiate between false and true ECN/STP brokers. There are some signs that need to be discerned and examined to locate a true ECN/STP broker prior to opening an account with them. Given below are a few leads that can help a trader distinguish between the two.
Traders make more profit by paying less spread. Therefore, brokers compete in offering less spread to attract traders to open accounts with them. False ECN/STP brokers, like some market makers, offer impossible low spreads to attract traders. This is possible because their liquidity providers are other market makers who are in control of the situation. Some of them offer even zero spread or a fixed spread. Spread cannot be a fixed number in the real money market.
These days the EUR/USD spread is just about 0.6 pips. Therefore if a broker offers a high spread of 2 pips or more, it may be that the broker is a false ECN/STP one. It is obvious that the spread had been added to without information to the clients.
True ECN/STP brokers have no control on the spread offered because it is the liquidity provider that decides the spread that is to be offered. Though they may be in a position to add markups, they cannot take it below the amount offered. Commission is the only method through which they make their money. Adding to the spread can help to identify false ECN/STP brokers.
Any broker that offers a swap-free account is not a true ECN/STP broker. Any liquidity provider will have to charge a swap. This is a stream of income that they cannot do without as they have to pay others including dealers. The swap amount is calculated using a specific formula that uses the same interest rate. However, different liquidity providers charge different swap amounts because it is under their control.
#3: Lot Size
A true liquidity provider (like Goldman Sachs, Bank of America, etc.) never supports micro-sized lots (say 0.01). Therefore, any broker that offers micro-sized lots are either market makers or false ECN/STP brokers.
Strong liquidity providers usually offer a leverage of 100:1 as a maximum. Any broker that offers more leverage is clearly a false ECN/STP broker. It is also important to note the fact that some brokers lower the leverage during weekends to protect clients’ funds though this is not true. Any broker that changes the leverage is a false ECN/STP broker.
With true ECN/STP brokers, traders can use scalping techniques and robots to close their positions. This is because they do not care how much money the trader makes. False ECN/STP brokers do not allow traders to use the scalping technique as they are disadvantaged when traders make small profits. They place limits on the profits that are to be made by traders.
#6: Stop Loss, Targets, and Trailing Stop Loss
False ECN/STP brokers place limits on parameters such as trailing stop loss, stop loss and targets. They do not allow the traders to set them too tight. True ECN/STP brokers do not place any such restrictions.
Bonus is yet another factor that distinguishes a true ECN/STP broker from a false one. Brokers that offer high bonuses (sometimes 50 percent) have to be checked out properly. This is done to entice small time traders who do not have the investment amount to open an account. Little does the trader know that false ECN/STP brokers can make it difficult for them to earn through the trades. Ultimately it is trader that loses
#8: Negative Balance Protection
Traders should be wary of brokers that offer traders negative balance protection. In case of true ECN/STP brokers, they clear up all the dues with the liquidity providers in case the traders’ accounts go negative because of reasons beyond their control. False ECN/STP brokers, however, never mention this to a brand new trader because then they would not sign up at all. They end up taxing the traders in case the balance does go negative.
Most true ECN/STP brokers are connected to more than one liquidity provider at the same time. The electronic system chooses the one that is offering the best terms and the order is automatically routed to the specific provider. This is the best service that is possible for the trader.
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