Taking the Mystery out of STP in Forex
Those new to the forex market will often hear the terms STP (straight through processing) and NDD (no dealing desk) thrown around quite loosely. When these terms are not clearly defined, they sometimes lead to misunderstandings which can be confusing for traders. These misunderstandings can often lead to a broker unfairly being blamed for what is otherwise a normal, and fully compliant business model.
The Hot Potato That is RiskWe like to use the “hot potato” analogy to describe risk, which is at the core of understanding the definition of an STP broker. Let’s consider a very simple example of straight through processing. Imagine that as a trader you buy 1 lot of EUR/USD. In this example, the broker you traded with acts as a counterparty to the transaction, meaning it has effectively “sold” 1 lot of EUR/USD to you. Although it’s far more complicated in reality, to stick with this simple example, we like to use the term zero sum game: your loss is the profit of the counterparty and vice versa. Before going further into our example though, we’d like to stop. The reason is that we find at this stage, much of the confusion associated with this concept often happens.
Let’s imagine in our example that the trade you opened is now in profit. We’d like to emphasize something important here. Just because the trade is in profit for you, doesn’t necessarily mean the broker is at the same loss. The reason is that unlike a trader, who can only buy or sell, a broker has many options to manage the hot potato known as “risk.” Perhaps the broker found someone looking to sell at the point you are looking to buy. In such a scenario, the risk the broker took was offset, ie the potato was passed to the other trader.
In another scenario, the broker might decide to send the risk of your trade to one of its counterparties, which is often what we think of as straight through processing or NDD. In this example, the risk is passed from the broker to someone else. It’s important to note that the risk is still there, but like a hot potato, it’s simply been passed on to another entity.
The STP MythOne of the biggest myths about STP is that it’s inherently better than a market maker model. This is similar to saying that convertibles are good cars, and sedans are bad. There are pros and cons when trading with either a dealing desk broker or STP broker, which is something we discuss further in this article where we compare STP vs DD. For the purpose of today’s point, STP is simply one way a broker handles risk. Keep in mind, tthough that the risk is still there so the measures taken by whoever holds the “hot potato” might result in slippage or impact execution in other ways.
As forex industry experts, Atomiq Consulting can provide guidance in selecting a true STP broker that fits your specific needs. In addition, we can also guide you with understanding these concepts so you can make the best choice possible. Feel free to contact us for more details.
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