What is STP in Forex Trading?
Those new to the FX industry will often hear the terms STP (Straight Through Processing) and NDD (No Dealing Desk) thrown around quite loosely. Without a clear definition though, it’s quite easy to become confused on the subject.
In fact, experience has shown that brokers are often unfairly blamed for what is otherwise a normal, and fully compliant business model. For this reason, whether you are new to trading FX , or wish to launch your own forex broker, it’s important to understand the meaning of STP in the forex industry.
The Hot Potato Known As Risk
To better understand STP trading, we like to use the “hot potato” analogy. Let’s consider a very simple example of how to understand Straight Through Processing, often referred to as STP, in the forex market. Imagine that you buy 1 lot of EUR/USD in your live trading account. 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. To recap, you buy 1 lot of EUR/USD which was sold to you by your broker.
Although it’s far more complicated in reality, to stick with this simple example, your loss is the profit of the counterparty and vice versa. Before going further in our explanation, we wish to stop and make an important clarification. Many of those new to forex industry will often assume at this point that the counterparty risk we’ve described means that every time a trader loses, the broker gains, which is not true. We’ll shortly explain why this is the case.
Understanding Risk Management in the Forex Market
Let’s imagine in our hypothetical example that the trade opened is now in profit. Just because the trade is showing a profit in your trading account, doesn’t necessarily mean the broker is at the same loss. In fact, this is a mistake made by many of those who launch their own brokers. It is often assumed that the management of risk simply involves categorizing traders in different groups and walking away, which is a far too simple take on the market. Such an assumption has led to the downfall of what may have otherwise been a successful brokerage.
The reason it is incorrect to assume that a profitable trade immediately results in a loss for a broker is that unlike a trader, who only has the choice to buy or sell, a broker has many ways to manage this hot potato known as “risk.” Going back to our example, perhaps the broker found a seller at the point you entered your buy order. In such a scenario, the risk the broker took was offset, ie the potato was passed to the other trader, and most importantly the broker has no risk at all!
In another situation, the broker might decide to send the risk of your trade to one of its liquidity providers, which is often what we think of when discussing Straight Through Processing (STP) also known as NDD. In this situation, the risk is passed from the broker to some other counterparty, either a liquidity provider, bank or hedge fund. The important takeaway is that the risk is still there, but like a hot potato, it’s simply been passed on to another entity, which is now their problem to manage.
The STP Myth – Understanding How Forex Brokers Make Money
One of the biggest myths surrounding STP in the forex industry is that it’s inherently better than a market maker model. This is similar to declaring that convertibles are always excellent automobiles with no flaws, and that sedans are consistently bad. In reality, neither business model is optimal as there are both pros and cons to working with each one. The decision ultimately comes down to the preferences of the trader because just like someone’s taste in automobiles, people are unique in what they value and demand.
For the purpose of today’s article, though, STP is simply one of the several risk management tools a broker has at its disposal. It’s important to keep in mind that risk is still there, so the measures taken by whoever holds the “hot potato” might result in slippage or impact execution in other ways.
Launch Your Own STP Forex Broker With Atomiq Consulting
We hope the above examples were useful in better understanding the meaning behind STP in the forex industry. If you are new to forex trading and require assistance in selecting a professional and reliable STP broker, we are more than happy to guide you. In addition, if you’d like to build your own custom white label and launch an STP forex brokerage, our team of consultants remain at your disposal.
To learn more about the most reputable STP brokers in the forex industry, or obtain guidance in launching your own forex broker, don’t hesitate to contact us today!
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