- Act as a counterparty for all trades, routing orders through dealing desks.
- They divide clients to 2 groups called: A-Book and B-Book.
A-Book contains winning clients. The broker hedge the client's position with their liquidity providers. As this is done automatically by algorithms the broker still makes money through spreads.
B-Book contains losing clients. The broker takes the other side of the client's trades. Means when the trader loses the broker makes profit.
- Spreads are floating but almost always the same value. Some MM brokers offer fixed spreads aswell.
- Traders can't see the real market quotes. Transparency of dealing desks differs at brokers.
STP Brokers (Straight-Through Processing)
- Never trade against the client.
- No dealing desk or intervention. All orders are sent directly to their liquidity providers. The more liquidity providers they have, the better prices and fills they can provide.
- Make money on spreads. They add mark-up to the price that they get from their liquidity providers. eg.: they get a price with spread of 0.6 pip, they make it 1.6 pip to the client.
- Traders can see the real market quotes (with the mark-up that the broker adds).
ECN Brokers (Electronic Communications Network)
- ECN Brokers pass your trades to an ECN pool where the participants are mainly banks, hedge funds and brokers. They are the counterparty for all trades.
- Participants in the ECN pool interact with each other.
- Orders are matched real time. You can place your bid 0.1 pip higher than the actual bid price and you might get a fill.
- Charge clients with commission. Thats their only income. They never use mark-up.
- Shows market depth. Order sizes are visible for everyone.
Unfortunately many brokers advertise themselves as ECN/STP brokers and in the reality they transmit your orders to a market maker company that is owned by them in most of the cases.
Every type of broker can be perfectly reliable. MM brokers are mostly suitable for beginner traders, while STP and ECN brokers can be the right choice for more experienced traders. Biggest advantage of MM brokers is that your stop levels are guaranteed. At STP / ECN brokers you might face 2-digits slippage during major news releases when liquidity gets really thin. They usually offer better trading conditions (lower spreads), but at the end of the day you might end up with higher average spreads than MM brokers because of the slippage.
MiFID II is coming in January 2017, brokers will be required to prove that they are offering the best possible prices to their clients. Will be interesting to see how it changes the broker world.