The Hard Reality How the Vast Majority of ECN and STP Brokers Work
Old times when market making brokers were number one are long gone. Forex traders have recognized that trading directly against your broker is in the long term unreasonable and clearly unprofitable. The reason is simple.
When you profit from a trade with a market maker broker, that same amount of money the broker loses. And, conversely, when you lose money, that same amount of money, the market maker broker earns.
Market makers can hedge profitable trades of their clients on the interbank market. But they usually don't do it as they are greedy and want to profit from their clients as much as possible (even to the detriment of clients).
The result from these situations and these attitudes of market maker brokers is clear. Even if you would be the best trader in the world, you would never be profitable (beating your broker) over the long term.
Quite simply such a broker would not allow you to be profitable. They would probably do spread widening (huge numbers), re-quotes, hunt your Stop-Losses, artificially increase slippage, etc. until you begin to lose.
It's like if you were trying to break through a strong wall with your head.
Unfortunately, the largest number of traders (some 90%) lose all by themselves anyway, even if no one is working against them. Brokers know this and they try to take advantage of this statistical fact by pocketing the money the traders lose.
As you may know, at face value, the A book business model (ECN or STP) for brokers is much less profitable (profits come from spreads and commissions only) than the B book business model (market maker, where profits come from client's losses also).
Of course, brokers who use the model A book realized that they are missing out on huge profits by just sending all orders straight into the market.
So they began thinking how they could make higher profits too.
Finally, they explored an elegant solution.
For better understanding, first, let's review how ECN and STP brokers work. These type of brokers, unlike the market maker brokers, always redirect your orders (transactions) into the market.
So they do not leave your orders against their own books (orders), and they never act like a counterparty to all your trades as a classic market maker would. That's the gold truth and it is the way how completely all of today's STP/ECN brokers work.
Let's dip deeper on this to see where is the problem.
Redirecting the trade orders to liquidity providers is not the questionable fact with ECN/STP brokers. However, it does not tell us anything about where exactly all orders are being sent and who are the liquidity providers.
It may shock you to learn that the vast majority of all ECN/STP brokers (around 90%) send your orders to their contracted market makers (or to only one market maker) which act as liquidity providers and with which they share the profits from the losing positions of their clients.
Due to the fact that the end market maker (where your transactions actually take place) acts as your counterparty (uses the B book business model) his profits are considerably higher than the actual gains of your broker which uses the A book business model.
What does this mean exactly?
Simply, ECN/STP broker sends your orders to another company for execution instead of sending it to the real market.
In essence, it acts as a hidden market maker broker even though it looks like an ECN/STP broker at first. The broker sends your trades to the only liquidity provider which has an agreement with them and then they share the profits from your losses between each other.
Now, you probably understand why it is so difficult for the overwhelming majority of traders to be profitable in the long term.
The efforts of these wannabe ECN/STP brokers are probably clear by now. In order to generate maximum profits for them, they want you to lose money. And, we're back where we started, again at the issue of conflict of interest with your broker that trades against you.
Here, although, the broker does not directly trade against you, the principle is still exactly the same. Passing the trade to another party that trades against you is just a way to hide their business model.
Given this, if we take the number of market maker brokers and ECN/STP brokers, we find that 98% of the total number of brokers trade directly or indirectly against you!
That is not a good position to be in as a trader.
So what might the solution look like?
Remember, you should always try to avoid a broker that trades against you because ultimately you can never be profitable over the long-term in a conflict of interest situation.
Therefore there remains only one solution - to find a broker that sends all your orders and transactions to the true interbank market.
But how to find such a broker?
It certainly seems like looking for a needle in a haystack.
Based on this problem, we created the Real Brokers Reviews page at the FX Trading Revolution website.
We tested hundreds of brokers on real accounts and have done thousands and thousands of comparative tests. What is the result you might wonder?
The difference between brokers is huge and has a direct impact on the profitability of our trading. It is striking how the absolutely identical trade is profitable at one broker, but ends up in a loss with the second broker.
Different spreads and trading conditions affect whether a certain trade will be profitable or not, however, some of the dirty practices that Forex brokers are usually involved in, also played a major part in turning the trades to losers.
At the end, we can conclude that when choosing a broker things are not always what they seem and we should always be extra careful and meticulous during this process.
For more information on our tests and results visit also our Truth About Forex Brokers page.