CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 51% and 89% of retail investor accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
Understanding the significance of STP is best achieved within the context of how it differs from a Market Maker price quoting system. As such, it makes sense to explain both and their advantages and disadvantages.
Price Quotes in CFDs Trading
When a trader takes a CFD position they, in theory, buy a financial instrument at a close approximation to its present market price. There is a buy and a sell price, referred to as the bid and ask price and the small difference between the two is the "spread". This is where the entity on the other side of a trade makes their money.
However, the reality is that the situation is not quite as simple as that. There are actually two main ways in which different brokers arrive at the price offered on CFD markets that can be traded on their platforms & Market Maker and STP. Each has pluses and minuses for traders.
Market Makers
Some CFD brokers have a Market Maker quoting model, which can also be referred to as a Dealing Desk (DD). In this model, it is the broker themselves that offer traders the bid and ask prices on a given CFD. The pricing provided should closely reflect the actual market price though can, in theory, slightly diverge. By how much a MM broker's pricing can differ from the underlying market is determined by their financial regulator.
Generally, MM brokers will try to offset the trading position of one client against that of the other, under the presumption that there will be long and short trades held simultaneously by different traders using the broker. If this is not possible the next recourse is to hedge the risk with an external liquidity provider. However, the most important quality of taking a trading position with a MM broker is that the broker takes the other side of the trade. This means that if the trade goes in favour of the trader, the MM broker loses it, though in theory they will have hedged this loss.
Many traders consider trading with MM brokers to be an inherent conflict of interest and generally undesirable. This is a bit of a misconception and most MM brokers, particularly those under the regulatory regime of a strong regulator such as the UK's Financial Conduct Authority (FCA), offer a fair market price. There are also a number of advantages for traders which result from the greater control that MM brokers have. These include:
However, there are also disadvantages such as:
- The potential for a conflict of interest.
- Spreads are generally wider in comparison to STP broker quotes.
- Slippage and requotes are more common.
- Bigger positions may be declined if the broker doesn't have the liquidity to take on the risk.
Straight Through Processing (STP)
In its wider application in financial services, STP means information electronically processed by one party to begin a settlement process does not need to be re-entered by subsequent recipients of that information along the sequence of events.
Within the specific context of online trading, STP price quoting means that the broker, unlike in the case of a MM broker, does not take the opposite side of their clients' trades. The broker facilitates the matching of the trade position with a counter-party in market, which is made up by liquidity providers and other financial institutions. The bid and ask prices quoted to traders are those of the main market.
In an STP brokerage model it makes no difference to the broker whether a trader wins or loses a trading position. The broker makes its money purely from commission charged on each trade, which reassures many traders of transparency and a lack of any potential conflict of interest. The main advantages to the trader of trading with an STP broker are:
- No potential for a conflict of interest with the broker.
- Tighter spreads.
- Requotes and slippage rare.
- Larger trade positions can be taken.
Disadvantages include:
- Micro-lots are not available so significantly larger trading capital is required for effective risk management.
- Spreads are less consistent and may widen considerably during particularly volatile periods on a financial market.
- The broker charges commission so each trade placed is more expensive.
Should I choose a Market Maker or Straight Through Processing Broker?
As is probably clear by now there is no black and white answer to this question. However, as a general rule of thumb, the lower costs and the option to trade micro-lots means that MM brokers are the better option for beginner traders who will work with less capital and take smaller positions. The advantages of STP brokers outweigh the higher cost of using them when more valuable trade positions are taken. As such they tend to be the preferred option for more experienced traders working with bigger trading accounts.
Many of the bigger brokers now offer both MM and STP trading accounts in recognition of this divergence in the benefits and drawbacks to the two models.
Which Regulated Brokers Offer STP
XMbroker that is regulated by a reputable regulator as they will be supervised and monitored to ensure that they are acting in accordance with the highest standards when it comes to their client services.
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