The days when trading was just for a chosen few are long-gone. In this day and age, anyone with a small capital, willingness to learn, and access to the Internet can enter the vast world of Forex trading. The financial markets are not off-limits for smaller-scale retail investors – there are plenty of brokers out there who would gladly have you as a client for a relatively small amount of money. However, before you embark on this journey, it is important to choose the type of broker you wish to trade with.
Many novice traders have heard of the main types – Market-Makers, STP (NDD) brokers, and ECN brokers – and might simply follow the common understanding that ECN is always better. And while it is true that trading with an ECN broker comes with considerable advantages, there are also some disadvantages – especially for smaller investors. It is important to first understand the main differences between the business models of all of these brokers to then be able to make up your mind about which one suits your needs better.
No matter the type of broker you choose – ECN, STP, or Marker-Maker – remember to turn to a legitimate, licensed company regulated in a strict jurisdiction.
Middlemen, Counterparties, and Intermediaries
STP (or Straight-Through Processing) brokers are the most common type of broker. They act as the middleman between you, the trader, and different liquidity providers – banks and other financial institutions – that provide funds (liquidity) and make trading possible at all. Clients of such brokers are not in direct contact with the liquidity provider – the broker is the one who takes information from the specific liquidity provider and forwards it to the client, and vice versa.
We have a second type of broker in the face of Market-Makers – such brokers trade against their clients and set bids and ask prices on their own platform and let you buy or sell assets. They are counterparty to all client’s trades. This is their main source of profit. When you open a position, the broker will open an opposite one of the same size – if you want to bid, the broker would ask. When you have a winning position, the broker has to pay you and lose money. However, if you have a losing position, they collect a payout. This means that there is a conflict of interest because your losses are the broker’s gain. Such brokers are usually called market-makers because it is the broker that “creates” the market.
ECN (Electronic Communication Network) brokers, on the other hand, connect traders directly with the liquidity provider – they act as intermediaries but don’t interfere in the communication in any way. All the broker does is provide a platform where you are connected to the liquidity providers directly. A liquidity provider can even be another client of the broker. You are then charged a fixed commission for your trades, and that is how the broker makes money – not from your losses. Moreover, ECN brokers connect traders with multiple liquidity providers, which means that your orders would be executed at the best possible price.
Why Are ECN Brokers Better?
No trading against clients
As explained, market-makers trade against you because it is profitable – this is how they make money. However, if a broker wins when you lose (or the other way around), a clear conflict of interest arises – it is against the broker’s interest for you to open a winning position.
STP brokers, on the other hand, profit through price differences (or mark-up) in a bid and ask for orders between themselves and the liquidity provider, which means that there is no conflict of interest. As long as you trade, the broker would be making money. However, you will have no guarantee that you will be getting the best possible price, and certain delays are possible – after all, it takes time for the broker to deliver your offer to the liquidity provider and execute it.
ECN brokers also do not bet against you – they just connect you to liquidity providers. The conflict of interest is avoided because the broker gets a commission whether you have a winning or a losing position. You are connected directly to the liquidity providers through the broker’s platform, which allows fast execution and lets you choose the best possible prices.
Better prices
As mentioned, ECN brokers act as intermediaries between you and different liquidity providers. They provide access to a platform where you would be connected to different liquidity providers who can offer different prices – some of them better than others. Your orders would be executed at a price you, as a client, find the most suitable at the current moment. This means tighter spreads, better prices, and lower trading costs for you as a whole.
No requotes
Market makers would usually execute your order at the price you have offered – if that price changes, they would not execute it at all and would instead inform you about the change. They could then execute your order at the new price – this is called a “re-quote.” Re-quotes rarely work in the trader’s favor and are therefore not desirable. With ECN brokers, orders are executed faster and more efficiently, with no unnecessary postponements – that is why re-quotes are far less likely.
Transparency
With ECN brokers, you get access to the most recent market information as well as to a detailed and accurate history of prices – that is why it would be harder for the broker to manipulate prices. Moreover, the broker is not acting as a market-maker but just providing you with information and prices straight from the liquidity providers, which means that such manipulations are highly unlikely.
Are There Any Disadvantages?
Unfortunately, there are also some disadvantages to choosing an ECN broker that might make smaller investors think twice.
High Minimum Deposits
The service ECN brokers offer usually more expensive, mainly because they let you communicate with liquidity providers directly. That is why, as a rule, ECN accounts are more expensive. While it is fairly easy to open a Micro trading account with an STP broker for as little as $5, ECN accounts could cost as much as $1000.
Higher Commissions
ECN brokers do not make money through spreads – they charge a fixed commission for each of your transactions instead. Commissions vary from broker to broker but could result in considerable expenses. That is why trading small would not be a good idea – your potential profits might disappear quickly as a result of the bigger commissions.
No Micro-Lots
Another reason why an ECN broker would not be a suitable choice for a small-scale trader is the lack of micro-lots. You would not be able to open a position for less than 10 000 currency units due to the fact that the cost and expenses for liquidity providers are also quite high.
Should you choose an ECN broker?
Trading with an ECN broker provides access to an efficient and transparent trading environment where you are directly connected with different liquidity providers. This means both better prices and no conflict of interest. However, this type of trading might be better suited for traders who are willing to open bigger positions and have no problem paying higher deposits and commissions. If you are just testing out the waters and do not have the desire to trade big, it might be better to turn to an affordable STP broker who offers low-cost trading and a convenient platform.
