When a company is going to get its feet wet in the FX industry, brokerage business models are among the core components to think over. What do such models mean? A model influences the way your business will face expenses and get profits; this is why compare all the possible solutions to come up with the best decision that matches your corporate goals.
As for the basic model types, those are circled around STP, ECN, and DMA brokerage types; meanwhile, some companies mix features of several models to get the best option from every solution.
When a beginner business owner is looking for the answers to how to start a Forex business, the preferred model is a stage you need to keep in mind foremost.
STP (Straight Through Processing) model: definition and key pros
Beginner brokerage businesses understand the STP model as the most convenient and beneficial solution for traders; this is why such a model is about to guarantee massive inflows of new clients. Let’s dive into the definition and main advantages of brokers acting straight-through-processing.
The model means that all the orders placed by your traders are going to be transferred directly to the FX market. Meanwhile, brokers themselves get no access to the market, and liquidity providers are the required links of the chain to make this system work. According to statistics, 85% of businesses represented in the Forex industry have chosen the STP model.
Straight-through-processing brokers do not impact the trading process, as all the quotes are delivered by liquidity providers. Market makers (banks, large funds) execute requests transferred to the market, and a brokerage firm itself gets the role of an observer.
Requests are delivered directly to the market; this is why no price slippage or requotes take place. An STP brokerage firm gets its profit from trades made by its clients – earnings look like commissions from every deal. The more orders are placed by a trader – the more fees a company gets. As such, the STP model is interested in a trader’s progress and successful deals. Furthermore, the system introduces no limits related to trading strategies.
What are the principal advantages of this model?
- Requests placed by traders are executed instantly by the most beneficial prices.
- No price slippage and gaps take place. Spreads are minimum.
- A brokerage firm doesn’t impact the trading process.
- No limits for scalpers are introduced.
- Requests are transferred directly to the interbank market.
Many brokers called STP ones do not correspond to its features, and newcomer business owners need to understand what a true straight-through-processing model means.
First and foremost, take the minimum deposit sum into account. A brokerage company is usually not interested in mini- and micro-accounts; this is why deposits mainly start with $500 or $1000 (rarely – from $200-300).
The next characteristic includes an opportunity to open pending orders close to the current asset’s price. One more important feature of an STP brokerage business lies in no limits related to trading strategies. Traders have an entirely free hand.
ECN (Electronic Communication Network) model: definition and key pros
To start with, beginner FX business owners need to understand the meaning of ECN, an abbreviation from the Electronic Communication Network. Such a system is understood as the network for the purchase and sell of exchange goods, including FX currencies.
All the requests transferred to an ECN are added into the order book – the system is based on the order matching system – the engine is looking for the correspondence between ask and bid prices.
The first independent ECN system appeared in California in 1999. As of today, tens of ECNs are available globally.
What does the ECN business model mean, while we are talking about brokerage businesses? Such a model is a type of NDD broker (Non-Dealing Desk) which means a company needs the help of liquidity providers.
An ECN broker consolidates quotes from different market participants. A firm gets access to liquidity provided by large market makers and liquidity aggregators. The core function of this model lies in finding the best quotes for their clients.
For instance, a client opens a long position, and every market participant gets the right to offer its liquidity. Imagine there are three banks-market makers offering the following quotes: 1.1317, 1.1318, and 1.1319. When a brokerage company needs a provider to cover a bid order, it selects a bank with 1.1317.
While talking about the conflict of interest, the ECN model follows the same principle as an STP broker – bid and ask requests are executed by market makers; this is why a brokerage business is interested in the growth of trades.
The principal advantages of an ECN broker are as follows:
- Orders are executed instantly.
- Traders get direct access to liquidity pools.
- Floating spreads enable clients to select the best option.
- An ECN system maintains the integration with advisers, algorithms, and risk-management instruments.
- An ECN model is entirely anonymous, offering fair quotes to traders.
DMA (Direct Market Access) model: definition and key pros
This brokerage business model enables traders to get direct access to the FX market. What does it mean? Brokerage firms place bid and ask requests on behalf of their users. Market makers execute those orders within the shortest time.
The first brokerage companies offering such a model appeared in 1969; meanwhile, the solution commenced being in demand in recent years.
This option doesn’t include the direct participation of mediators. Companies provide traders with access to the marketplace, offer consultations and software. A broker’s role is rather limited; this is why fees are lower.
The pros and main characteristics of ECN and DMA models are mostly the same, while a DMA broker includes its commissions in spreads. As for the principal advantages of the model, the following pros are outlined:
- Brokers provide access to exceptionally high liquidity, guaranteeing the narrowest spreads.
- Trading and quotes are as transparent as possible.
- No limits related to trading volumes and terms take place.
- There is still no conflict of interests between a brokerage company and traders.
Hybrid brokerage models and their goals
All the herein-given brokerage models have a set of pros and cons; this is why brokerage firms may hesitate whether a certain model matches its business goals. This is why hybrid models combine the advantages of the DMA, ECN, or STP model to get the required positive features and minimize negative size. The most widespread hybrid model combines features of ECN and STP.
DD (Dealing Desk) model: when do brokers act as market makers?
Opposed to the Non-Dealing Desk model when a brokerage firm provides its clients with access to the FX market directly, there is a Dealing Desk solution when the role of a market maker is performed by a brokerage firm.
A brokerage firm includes traders’ bid and ask orders into its own order book, and the matching engine is claimed to find the correspondences between those requests. As such, brokers get no commissions from trades – such companies capitalize on their clients’ losses.
Why do traders understand this model as less-beneficial than ECN or STP solutions? When the matching engine detects no correspondence between bid and ask orders, traders are suggested to increase or decrease the given prices. This said, spreads are high enough. Sometimes, spreads ruin trading strategies.
According to experts, the DD model works when the number of clients exceeds 1 million; otherwise, the trading volumes are insufficient to cover the needs of active users.
MTF (Multilateral Trading Facilities) model
Multilateral Trading Facilities is a retail exchange; this is why the MTF model implies a brokerage firm that deals with such an exchange.
Brokers do not use alternative sources of quotes, relying on the ones provided by market makers. MTF contractors are obliged to execute orders by prices they’ve offered. The main goal of an MTF model is to connect buyers and sellers.
The model has much in common with the ECN solution. MTF brokers are not widespread in the Forex market.
The importance of the right model
The brokerage business model determines the path a company is going to pave; this is why business owners need to compare all the pros and cons to understand which model perfectly matches their goals. When it looks like a mission impossible, ask qualified experts for help – B2Broker, the leading provider of liquidity and technologies, is ready to bring the best-matching solution to your head.
