How Do ECN Forex Brokers Work? | FxAdvice Blog | FxAdvice
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HOW DO ECN FOREX BROKERS WORK?

Choosing a Forex broker 0comments 10,724 views
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Still some 5-10 years ago, words like ECN, STP, NDD, DMA were known only to a small circle of people. Now every second broker uses these terms to attract new customers.

In this article you will find exhaustive information about ECN/STP/NDD/DMA brokers, as well as get answers to the questions:

  • What are these designations and what is the difference?
  • How do brokers work with these technologies?
  • How to understand where is a real market and where are not?

BASIC TERMS

We will manage without an abstruse definition and a dull copy/past from Wikipedia and explain our own words.

WHAT IS AN ECN BROKER?

ECN or ECN broker (electronic communication network) – a system that unites banks, brokerage companies and traders to perform trading transactions between them without intermediaries. ECN is characterized by tight spreads, the absence of any bans on trade, high execution speed and huge liquidity. The payment for the use of ECN is usually expressed in commissions from trading volume.

The first ECN appeared back in 1969, but they became popular only recently.

WHAT IS A DMA BROKER?

The DMA system is similar to ECN. There are not so much differences between them. In DMA or DMA broker (direct market access) – pension funds, investment funds, joint funds, on the one hand, and investment banks, and broker companies, on the other, participate. The first party buys and sells assets to the second party, which is the liquidity provider for these transactions. Simply put, the first party is the client of the second party. Provision of such services is performed by an independent company.

The main characteristics of DMA and ECN are the same, except that it is worth noting the higher liquidity of ECN systems. But for an ordinary trader, this difference is invisible. Most often, the entire commission for the use of the DMA system is putted in the spread.

WHAT ARE NDD AND STP BROKERS?

As it is easy to guess, the NDD or NDD broker (no dealing desk) is the absence of dealing desk and the withdrawal of all orders for liquidity providers – DMA or ECN systems. This principle of work helps to avoid the main evil of all traders – conflict of interests! The advantages of NDD are similar, like DMA and ECN, which allows the client to be much more confident in their trading.

STP or STP broker (Straight Through Processing), in its essence, is synonymous with NDD. Transactions are deduced directly to liquidity providers and there is no dealing desk. But there are two big differences – a higher execution speed and a significant reduction in the calculated risk. The second point refers more to financial institutions, but exactly they caused the appearance of STP.

It is worth noting that very often under the name of NDD, it is the STP-technology for the processing of orders. But do not confuse ECN/DMA and NDD/STP, these concepts are different from each other:

  1. ECN and DMA are platforms, and STP/NDD is the technology of order processing;
  2. ECN/DMA implies (in most cases) the use of STP technology;
  3. ECN brokers allow traders to trade on the site where different participants of the financial market are already united, therefore it is not necessary that your transaction will be executed by the liquidity provider. It can be the same trader as you or a private foundation. There is also no specialization of participants for tools or other factors: everybody trades as he wishes.
  4. STP brokers (or brokers with the NDD system) send orders to a particular liquidity provider (usually investment banks). However, there may be several such suppliers, because different providers specialize in different classes of assets or instruments. Therefore, counterparties for, for example, EUR/USD and AUD/USD may differ. Also there are a lot of other factors of choice: time, volume of the order, price, and so on;

 

HOW DO ECN/STP BROKERS WORK?

Thanks to the FIX protocol, ECN/STP brokers (as well as NDD/DMA) connect retail traders and top liquidity providers, helping their customers obtain more attractive institutional prices and trading conditions.

Scheme of work of such brokers: through STP technology, customer transactions are sent directly to the ECN/DMA system, where they fall into the “book” of orders. In this “book” are orders of banks, funds, traders and other participants of this system, where they are executed among themselves. When the system receives an order, the function of selecting the corresponding applications comes into play. It automatically executes orders that have the same price, volume, but have the opposite direction. Unfilled orders are shown in the system, that all its participants could see them.

The order book is not a routing system that sends a deal to a specific liquidity provider. All transactions are displayed anonymously, and any participant in the system can act as a counter party of your transactions. This excludes any possibility of conflict of interest and provides full transparency of your work, which positively affects the trading conditions and, as a consequence, the results of the trading. Unlike “bucket shops”, such brokers live only at the expense of the commission and are interested in making sure that you trade as much as possible and for longer.

The scheme of the typical DMA broker is shown in picture 1. Very often, this type of execution of customer orders is called A-book.

Picture 1. Work scheme of A-book

 ADVANTAGES OF CHOOSING AN ECN BROKER:

  1. Huge liquidity, as a result – tight spreads and better execution of trader’s transactions;
  2. Full transparency of pricing and trading;
  3. Absence of any manipulations with the terminal, requotes and other “ploys”, which bucket shops like;
  4. The ability to place orders within the spread and be, roughly speaking, a market maker;
  5. There are no restrictions on the duration of the transaction, its volume, and absolutely all types of trading are allowed;
  6. Lack of conflict of interest, the company benefits that the client would trade as long as possible;
  7. Reliability, access to ECN/DMA technology is very expensive, add an expensive license here and get a solid company with a stable financial standing;

DISADVANTAGES OF ECN BROKERS:

  1. Big volatility, for some traders this can be a problem;
  2. High entry threshold, for many real EC/ DMA brokers, the minimum deposit starts at $ 50,000, only a few provide a real interbank from $ 100 (but there is a question about LP);
  3. Lack of everyone’s favorite MT4 (its availability is not so terrible, if there is a license for a purely NDD broker);
  4. They are very difficult to find among the infinite number of forex market makers.

For the sake of fairness, it should be noted that all the disadvantages of such companies are not trading.

 

CONCLUSIONS. HOW TO DISTINGUISH A STP BROKER FROM A MARKET MAKER?

The real problem is to determine which of the huge number of companies are putting deals on the market, and who simply uses the terms EC/ DMA/STP/NDD for beauty. More and more companies are trying, one way or another, to use these concepts to whiten their reputation and lure new customers. Unfortunately, only very few traders can distinguish an honest broker from a market maker. We have chosen the main criteria that will help you in this difficult matter:

  1. The company should not be registered offshore. To be honest, we have not met a company that is registered, for example, in Belize, which takes deals to the real market yet;
  2. Full openness of liquidity providers. Possibility to receive a ticket from the broker where the LP is indicated, and not just the logos of well-known banks on the site;
  3. Low spreads and high execution speed of orders;
  4. The presence of a depth of the 2nd level, where all pending orders of the system participants are seen (optional);
  5. The ability to put pending orders inside the spread (optional);
  6. Availability of other terminals than MT4;
  7. It is desirable that the license would be purely agency, in which case the company cannot leave the transaction 100% at home. This is the most important condition!!!
  8. Requotes, freezing of a platform, “drawing” quotes, pins and other “miracles” should not exist! But remember, in the real market there are slippages and from this not to escape anywhere;
  9. Absence of any restrictions on transactions and trading strategies;
  10. It is advisable to carefully study the agreement that you sign before opening an account. There you can find all the necessary information. If everyone read it, there might be much less “merged” deposits.

These rules are tested not only by time, but also by money of those who became victims of “bucket shops”. Use these criteria, and you will significantly reduce your non-trading risks.

In comments write, whether you worked with ECN brokers, if yes, conduct their analysis on the given scheme and write the results.

If you are interested in the truthfulness of a broker, write the company name under this article, I will gladly evaluate it for you.

Do not know which broker to choose or want to know more information about any company – knock me in Skype vovkfx.

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Good luck!

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