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Two Non-Dealing Desk (NDD) Broker Types: STP and ECN

No doubt you will be shopping around for brokers and see that some seek to differentiate themselves from their competitors, or seek to differentiate their own internal platform offerings, using the industry lingo of NDD (Non Dealing Desk), STP (Straight Through Processing), and ECN (Electronic Communication Network). These technologies have come about as a much needed alternative to the once pervasive Market Maker (w/Dealing Desk) broker, which we have seen in the previous article, had the inherent problems of creating an artificial market, benefiting from client loss, and interfering with client execution. Because NDD represents a negative category, Non Dealing Desk, it is not a particular broker technology in itself, but instead implies the use of STP and ECN technologies that work without a dealing desk to route trade orders directly to liquidity providers, giving clients access to a real market with better and faster fills. 

This article will outline the pros and cons of the two new execution technologies, and reveal the possibility of a possible hybridization with a market maker behind the scenes:
  1. STP (Straight through Processing) 
  2. ECN (Electronic Communication Network) Brokers
  3. Hybrid Technology: STP/ECN with Market Maker

1. STP brokers

In recent years clients have had enough of Market Maker brokers with a history of cheating clients, and began to seek and demand from brokers more transparency, lower spreads, and faster execution. They do not want to be part of a market maker or dealing desk where the broker takes the other side of the transaction or engages in tricks of spread widening, execution delay and stop hunting. In response to this demand, many former dealing desk brokers switched over, or began to offer an STP platform. The abbreviation STP stands for Straight Though Processing and means that there is no dealing desk involved in quoting & controlling market prices (no market making). Instead, all orders are passed through to Liquidity Providers (other brokers and banks), where they are executed at the bid/ask rate given by those Liquidity Providers. NDD stands for Non-Dealing Desk and is generally a synonym for STP. 

So, in theory at least, an STP broker with no dealing desk will direct all orders to Liquidity Provider(s) which act as principal and counterparty to the client's trade. An LP takes the other side of the client's position, while looking to make profits by closing this position later in a trade with another party. Here there is much similarity with ECN brokers, who also direct all orders to larger parties, but in the ECN model the trades are passed to an anonymous ECN pool, where other liquidity providers - banks, hedge funds, brokers, investors - become counterparties to the trade.

When searching for an STP broker, it is good to know three things: 1) the depth of the liquidity pool (the number of liquidity providers); 2) the type of spread (fixed or variable); and 3) the type of execution (instant or market).

1. Choose an STP broker with the deepest liquidity pool. An STP broker has its own "internal liquidity pool" consisting of a predetermined number of liquidity providers that it has signed a business contract with. These liquidity providers then compete for the best bid/ask rates for orders coming from the STP broker. The more liquidity providers in the system, the deeper the liquidity pool, the better bid/ask quotes, and, as a result, the lower the spreads.

2. Choose an STP broker with variable spread. STP brokers offer two types of spreads, fixed and variable. An STP broker with variable spread works similar to an ECN model (but inside its own internal liquidity pool), picking the best bid from one LP and the best ask from another LP to deliver the best current spread to its own clients, plus a small markup that allows the STP broker to earn its profit. An STP broker with fixed spreads won't adjust spreads for clients based on the lowest bid/ask prices offered by the LPs and instead the spread remains fixed all the time, which is usually higher than the variable spreads. Since fixed spread is usually not as low as the variable spread, I am not sure why some clients might prefer it.

3. Choose an STP broker with market execution. An STP broker with market execution would make it a DMA (Direct Market Access) STP, instead of a regular STP that fills client orders through Instant execution on his own side. A DMA STP broker will pass client orders directly to the LPs, to be filled at best price by one of them with a small spread mark-up by the broker.
A DMA STP broker typically uses market execution to ensure that all orders are filled at the best rate. Since DMA technology shows real tradable prices, there will be less re-quotes and your trade should execute within microseconds of your click.

In contrast, regular STP brokers will fill client's orders through Instant execution on the broker side, and then go to offset these orders with the LPs. So mechanically there is a distinct difference. The orders are not passed directly to the LP via market order, and instead are put through on instant execution that is later hedged. This small lag window, where the broker is searching for the hedge, can tempt broker greed. The broker may seek profits from the hedging operation, and thus consequently can re-quote the client's trade if the broker cannot find a profitable hedging opportunity at the moment of the client's trading request. This requoting can be most noticably seen with a scalping system that fades short-lived spikes for a few pips profit; while in backtesting the system might be profitable on a demo with zero delay instant execution, in real time it might not be so profitable when the broker requotes the entry and fills it when it has already lost its spike advantage. Consequently, the DMA/STP broker has a number of advantages over the regular STP broker: it offers a greater number of liquidity providers, offers market execution without re-quotes, and welcoming traders of all types of styles, including scalpers and news traders.

2. ECN Brokers

There are probably more similarities between a DMA STP broker and ECN than differences. Both route orders the same way: the popular MT4 platform will most likely use a third party bridge software to connect to major liquidity providers, whether it be the contracted liquidity providers of the STP, or the anonymous liquidity providers that make up the ECN.  Both have variable spreads that are low and competitive, and both have fractional 5-digit pricing. 

The primary difference is in the routing destination. While an STP broker has set up contracts with each liquidity provider (LP), ECN brokers are connected to anonymous ECN pools without direct contracts. An electronic communication network (ECN) is like a hub where many major liquidity sources (banks, hedge funds etc.) get connected to find counterparties to the orders they cannot handle internally. 

In terms of fee structure, STP brokers add a small fee markup to the raw spread they receive, while ECN brokers charge a commission for every transaction. On the surface of things, it looks like the ECN is the purest breed of broker because they do not profit on the spread difference (actually, they probably mark up the raw spread just like the STP broker). ECN brokers can claim that they are interested in their clients to be winning; otherwise there will be no commission to earn. Yet STP brokers are also interested to see their clients trading profitable, so that a broker can continue earning on spreads. Moreover, the best of the STP brokers may only charge a small markup on the raw spreads they receive from the LPs, which makes their spread very competitive with the best of the ECN brokers. The real transaction cost for a trader at good STP broker then becomes much lower because there is no extra commission added. The real transaction cost for the ECN broker is the spread + commission, for every ECN broker charges a commission on top of a spread, which often makes the two combined a higher transaction cost than a low spread STP broker which does not charge any commission.

In terms of execution speed, the DMA STP broker is said to have an advantage over the ECN broker. The introducing broker website 100ForexBrokers makes the following case: 

DMA prices are streamed directly from liquidity providers, which are committed to their bid/ask offers. This ensures that there will be no re-quotes, rate rejects and partial fills. Due to the nature of ECN liquidity pools, where anonymous participants can place "illusive" orders and then reject them, traders might see more re-quotes, slippage and partial fills.

This might be a valid point, though it is hard for me to verify it. There are probably ECN brokers out there that also pride themselves on never giving a requote or partial fill. 

Taking the skeptical stance, it is possible that as trades of DMA or ECN model must be passed through an MT4 server in order to make their way to the different liquidity pools, there is still the chance that these brokers can turn on internal switches within the MT4 server platform itself that can cause execution delays, re-quotes and slippage for the client, if not for the broker, and any slippage that the client receives is profit for the broker.  In the end, the execution quality and speed depends on the technology of the bridge connection, the depth of the liquidity pools, and above all, the honesty of the broker.

As for lot sizes, most ECN brokers do not allow the trading of anything below 0.1, the reason being that few ECN liquidity providers allow trades below 0.1. That gives over an advantage to the many STP brokers which do allow micro lot trading. People opening up accounts smaller than 2K must look for micro lot sizing in order to stay true to smart rules of money management. Yet it must be remembered that the STP broker that does allow micro lot trading may be trading against you with their hybrid dealing desk, and so they might not like it if you are winning often from your micro lot trading. Recently there have been a few ECN brokers that have offered a minimum lot size of 0.01 as well, and thus the caution about trading in a hybrid dealing desk environment applies to these ECN brokers as well. However, money management does trump these speculative cautions. If I were trading with less than 2K, I would definitely look out for a micro lot STP/ECN broker because obeying sound rules of money management trumps any fears that the brokerage might eventually starting manipulating things against you if you win in their hybrid system.

3. Hybrid Brokers: STP/ECN + Maker maker

Many brokers claiming to be Non-dealing desk may behind the scenes run a hybrid model of STP/ECN + MM. Just because a broker says it is NDD, STP or ECN does not mean it is doing so all the time and that it is dealing desk free. Behind the scenes it can be running a mixed model, and for multiple reasons or motives. 

Motive #1: Flexible Lot Offerings

A desire to offer micro lots which are not allowed by the liquidity providers. When STP brokers sign business contracts with their liquidity providers (prime brokers), the contract terms sometimes specify that there is a minimum transaction level such as 0.1 lot that is acceptable by the liquidity provider, and consequently all smaller orders below 0.1 lot must be handled by the STP broker who then becomes counter-party to the transaction, similar to the Dealing Desk model. While it is nice that they are giving you the ability to trade with micro lots, you have to realize that they may be trading against you and that any profit you're making is their loss, and if your winnings are too much, the brokerage might not be happy about it and will likely flick on a number of internal switches to tilt the odds back in their favor. Thus if you really want your trades to be STP'd to the LPs, then you may have to make your lot size a multiple of 0.1, though that might not be wise option for people with low balance.

Motive #2: Desire for more profits.

Since it can be more profitable for brokers to take the other side of the transaction MM style, earning money on the bid/ask spread as well as when a client loses, it is very tempting for brokers to intermingle the MM model with the STP/ECN model even with orders beyond the minimum transaction levels. Just because a broker says that it is STP on its website does not mean that they are not also a market maker, and they might be able to get away this hybridization even if they are regulated.

With more sophisticated client profiling software available to brokers, brokers can more easily differentiate with better statistical odds the potential winning traders from the potential losing traders, and place the 5% winners through an STP or ECN model, and place the 95% losers through the market maker model. In this hybrid scenario, the broker gets to earn much more money, earning from the spread/commission and also from the losses of the clients, and most traders will not even notice a difference in spread or execution. Because the client profiling software is so advanced, and most potential winners have already been routed to the STP or ECN model, the broker often has no need to manipulate trades of winning traders via the dirty tricks of human or virtual dealers, such as widening spread, delaying execution and stop hunting.

Caution It should be pointed out that, though the client profiling software has become more advanced, some brokers claiming to be NDD can still run various forms of the virtual dealer plugin, even when the broker is using a pure STP model or ECN. There is nothing stopping the broker from messing slightly with the execution. All the trades have to pass through an MT4 server in order to eventually get to the liquidity providers, and thus some brokers may take advantage of this fact to tip the balance in their favor via internal tools available for this purpose. They can add more spread at different times or delay the execution at different times. If they add more spread at different times, that is more money for them. If you get slipped 0.2 pips and they don't get slipped at all, it is an extra 0.2 pips for them, a cost that comes out of your pocket. If the broker is not regulated (and sometimes it is hard to trust the regulations or the regulators), there is nothing stopping them from using the internal plugins to widen spreads or create slippage in their favor.

There are many STP and ECN brokers that do not engage in any of these manipulations, but is hard for any clients to measure this, other than trying to get a gauge on the number of client complaints about receiving spread deviations, delayed execution and consequent re-quotes and slippage.

Conclusion

Many of us did finally take the red pill and rebelled against the Matrix of the Market Makers, with their dealing desks deployed against us, by demanding more direct and transparent routing technologies. We did not want to be part of a market maker or dealing desk where the broker takes the other side of the transaction and thus bets against us, increasing his profits and odds of winning with unfair tactics of spread widening, execution delay and stop hunting. In response to this demand, many former MM brokers switched over, or new brokers emerged, that began to offer STP or ECN models to route orders directly to the liquidity providers, minus the dealing desk, allowing us to trade in a real market with better and faster fills. 

These STP and ECN style brokers are an improvement over the former dealing desk broker. Instead of making the market and taking the other side of the trade, these brokers pass through all orders to the various liquidity providers, which reduces their incentive to make us a loser (because they are not taking the other side of the transaction), and increases their incentive to make us a winner (because they earn more from spread or commission the longer we remain trading). Thus, while they might indeed have access to the internal virtual dealer plugins designed to manipulate trades (increase spread, delay execution and hunt stops), they are less likely to use it and may instead prefer to see more traders or EAs do well. Another bonus to us: given the increase and number of STP and ECN brokers each trying to vie for our business, we have seen the spreads of these types of brokers drop dramatically (even the commissions of ECN brokers have lowered), which has further reduced our transaction costs. As of this writing, however, I have noticed that the best of the STP brokers still have lower transaction costs than the best of the ECN brokers when you factor in the spread and commission. 

Nevertheless, as wonderful as the new advantages are in having STP brokers, particularly the new and improved DMA STP brokers, along with the ECN brokers, you must still be cautious in choosing the right one. As I have indicated, there is nothing stopping any of the brokers from being a dealing desk hybrid, taking the other side of the trade to varying degrees in order to lower the minimum lot size or to earn more profits. Moreover, there is nothing from stopping them from using the virtual dealer plugins within MT4 against us, increasing the spread or causing more slippage, both of which gives more money to them, even if they are not taking the other side of the transaction aka DD style. Sure, we like to think that most are honest, but greed can corrupt, and if they can find they can get away with earning more from a small degree of manipulation, they will evolve to doing more. Sure, we would like to think that there are Regulatory bodies that would police both the dealing desk hybridization and the virtual dealer plugin manipulations, but there are many legal loopholes these large corporations can jump through, allowing them to rob us legally, under the very noses of the watch-dog authorities that we hope are protecting us.

In the end, we do hope that the broker is registered and regulated by a respectable authority, as that still does count for something, but what counts more is EARNED REPUTATION: if you do not already know the broker is trustworthy, from reputation or reviews or experience, we have to be skeptical, and as they treat us fairly and win our trust, we will reward their honesty with more favorable reviews and our money. 

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