What are STP/ECN CFD brokers and should you be using one?

There is a lot of chatter in the tradesphere about STP/ECN brokers and the advantages and disadvantages of using them and if they really make that much difference to traders.

So, let’s take a look…

What does STP stand for?

STP stands for Straight Through Processing

What does ECN Stand for?

ECN stands for Electronic Communications Network

What does that mean?

Well basically it means that when you execute a CFD trade your order goes direct into the market. If you’re buying your broker is connecting you directly with a seller though an exchange.

Does ECN/STP matter?

Well yes in some circumstances and no in others.

It matters is you need lightening fast execution and are working decent trade sizes. However, if you’re working really big orders the underlying market may not be liquid enough to fill the order so in really big order cases you may be better utilising a brokers internal liquidity to get filled.

It also depending on how you want to pay your broker. If you want an all in price (i.e. no commission) then you can’t have direct market access. Because then your broker wouldn’t make any money. If you want clean prices and are happy for an additional commission charge to be added to the trade then you can get DMA. The advantage of STP/ECN for clean prices is that you get much better pricing because you can work orders inside the bid and offer.

However, most DMA brokers will have a minimum commission for traders so if you are a small trader, it won’t be cost effective.

Can ECN/STP help you make more money?

It certainly can’t help you put on more winning trades. But what it can do if help increase profits and reduce losses by minimising your execution costs. Costs can be improved by transaction speed and execution pricing.

How do ECN/STP brokers make money?

Unlike brokers who offer commissions built into the spread ECN and STP brokers make money by charging commission per lot, or per 1m or per share (depending on what you trade). You do need to factor this in when calculating your gross P&L versus your net P&L.

Where can you find an STP/ECN CFD broker.

You can compare DMA (direct market access) brokers here. But for the majority of private traders one of the major CFD brokers should be perfectly adequate.

Plus one other thing to consider is that DMA brokers often cater to professional traders so unless your account size is above £50k you won’t be able to open an account.

If you’re a hedge fund looking for a prime broker for DMA, you can use our prime broker finder tool here.

Does the B Book Model in, CFD trading, forex and spread betting really still exist in the current financial climate?

The B Book model is a term spread betting and fx brokers use to assign a category of clients that consistently lose money.  There are generally three books, and the terms vary between geographical location and broker so think of the allocation loosely.

A while ago we asked why no decent spread betting or CFD broker should actually want churn and burn clients. So let’s take a look at the three book types…

The A Book

The A book is the main body of the client base that the broker hedges or nets off positions against.  They are fairly natural on the profitability of these customers and take low-risk approach to their trading.

The B Book

The B book is assigned to clients who always lose money.  These are generally smaller new accounts that the broker will not hedge against or “internalise orders”. However, the terminology can mean different things.

To one broker internalising orders may mean netting off positions, to another internalising may mean not hedging them

It’s a fairly standard way to make money as a broker.  It’s not as bad as it sounds as the broker is providing a very low-cost way for small punters to access the world’s financial markets.

It would not be cost-effective to only generate income from these customers from spreads and finance charging.

On average it costs a spread betting broker about £1,500 in advertising sped to get a new customer, so they need to aim to earn more to be profitable.

In fact, client acquisition costs for brokers have risen significantly in the last few years. Finance Feeds highlighted this for Plus 500 (a CFD broker) back in August.

The B Book is usually assigned to the FX, Index and Bond markets, where trades are smaller but of higher frequency than the equity market.

The C Book

Doesn’t really have a place in today’s market as the rules towards firms operating their own prop books and personal account (PA) trading are now very strict.

In the past though, spread betting brokers used to be well aware of the clients that always made money.

They would sometimes follow the trades to make a bit of money trading themselves.

Now, though it’s too much of conflict of interest between the broker and the clients so doesn’t really happen now.

A book and B book in spread betting – why it doesn’t matter

If you’ve just spent the last hour googling the A and B book in spread betting because you’re angry that your spread betting broker may be taking the other side of your trades read on.

The A and B book in spread betting have traditionally referred to spread betting brokers either hedging or not hedging customer positions.  When a spread betting company hedges a client position it means that when a customer bets long £10 per point in the FTSE the broker goes into the market and buys a FTSE contract (one FTSE futures relates to £10 per point).  You can read about contract sizes on the ICE exchange here.

When a broker doesn’t hedge a client position it means that when a client bets long £10 per point on the FTSE they don’t offset the position in the underlying market and take on the risk that the client will either make or lose money themselves.

Spread betting firms usually refer to a set of clients they hedge or don’t hedge as the A or B book.

But how does the A and B book effect you as a trader?

The truth is it doesn’t in the slightest.  As a trader you have two outcomes when you trade the financial markets through a spread betting broker.

You will either make money or lose money on the position.

How your broker manages their underlying risk is not your problem.  In actual fact your broker not hedging your position may work in your favour.

Not hedging smaller bet sizes

Using the above example, you can see that one lot in the underlying FTSE market is equivalent to a £10 per point bet.  If you are only betting £1 per point on the FTSE, the broker can’t go in to the market and buy 10% of one contract.  They must look at their entire book and net the smaller positions off against each other when the sizes are manageable.

Keeping trading costs low.

If you trade the FTSE through a futures broker, then you are charged a commission plus exchange fess, plus clearing fees for every lot traded.  If you are trading one lot (£10 per point) the commission per trade could be as much as £12.  As the dealing costs are built into the spread when spread betting you don’t have to pay such expensive commisison.  For example, most spread betting brokers offer spreads on the FTSE of 0.8 points so in and out that is £4 round trip or £2 per side.

You can compare the spread offered by the major spread betting brokers here.

So what the bottom line?  Basically, it doesn’t matter if your broker is hedging your bets or not. If you are losing money it’s because of your forex trading strategy and you probably shouldn’t be spread betting anyway.  If you’re making money, you broker is probably hedging your positions as you’ll no doubt have a decent enough account balance to make it cost effective.

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ALL INVESTING INVOLVES RISK. Investing, Derivatives, Spread betting and CFD trading carry a high level of risk to your capital and can result in losses that exceed your initial deposit. They may not be suitable for everyone, so please ensure that you fully understand the risks involved.
ESMA & FCA Risk Warning – “CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 68-89% 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. Capital at risk”