The Difference of True and False ECN/STP Brokers

Since forex is introduced to the public, traders learn more and more every day. Few years ago, most traders would have no answer if you asked what ECN/STP was. Thanks to the Internet and the free information accessible to public through it, now most traders know how to choose a good broker and what a market maker and ECN/STP brokerage system is.

However, scams never stop cheating. Since most traders look for ECN/STP brokers to open an account with, many scam brokerages that were used to be market maker, call themselves ECN/STP now, just based on some small changes they have made in their systems. They are not true ECN/STP brokers. This is what you have to be aware of. So, what is the difference of a true and a false ECN/STP broker?

ECN stands for Electronic Communications Network. An ECN broker is the one that its platform is electronically connected to the network of international banks or liquidity providers. When you trade forex through such a platform, indeed you are communicating and trading with the real and true international currency market.

STP stands for Straight Through Processing. It means everything from placing the orders to closing them is done automatically and electrically without any manual intervention.

Does it mean that if a broker electronically and without any human intervention connects the platform you install on your computer to another organization called liquidity provider, it is an ECN/STP broker?

Technically speaking yes. It is an ECN/STP broker, because it routes your orders to a liquidity provider electronically and without any human intervention. But what if that so called “liquidity provider” is another market maker broker that belongs to the same company but with a different name or a sister company?

That is still an ECN/STP broker from the electronic and technological point of view. But it is a fake ECN/STP broker, because he routes your orders to another market maker broker that rips you off and shares the profit with him (the broker). Or, it routes your orders to a different system with a different name which indeed belongs to the same company. I mean they take your money from one pocket and put it in another pocket. In both cases, you are not trading with the real currency world. You are dealing with a market maker broker that wants you to lose.

Why do they do this?

They do it because they want to claim they are ECN/STP, not market maker. They proudly advertise it on their sites. As I mentioned, they are ECN/STP from the electronic point of view, but they are market maker indeed.

Who Is a True ECN/STP Broker?

A true ECN/STP broker is the one that its platform is connected to at least one trusted and well-known liquidity providing organization (like Bank of America, Goldman Sachs, JP Morgan, Citi Bank, Nomura, HSBC) that has nothing to do with brokerage firm and there is no relationship between them. The broker just routes your orders to the liquidity provider. The liquidity provider makes money through the spread and swap and the broker makes money through the commission they charge you. You pay the spread and swap to the liquidity provider, and the commission to the broker.

Nowadays, most true ECN/STP brokers are connected to several liquidity providers at the same time. When you want to place an order, the system automatically chooses the liquidity provider that is offering the best price, and your order will be routed to that liquidity provider. Therefore, your orders will be distributed among several liquidity providers and none of them will have any chance to know your account and go against you in case you make money. That provides the best possible service for you as a trader, and because liquidity providers compete with each other, they offer lower spread every day which is good for retail traders.

Some brokers are true ECN/STP brokers, but they increase the spread in addition to the commission they charge you. What they add to the spread is called markup. They are not allowed to do that, unless they let the clients know. However, many of them don’t inform the clients about this hidden fee and extra charge and when you ask them why the spread is too high, they answer that it is the market’s normal spread, which is a lie. So, even a true ECN/STP broker can cheat you too. Read this: 6 Ways Forex Brokers Cheat You.

So, when you want to choose a broker, make sure it is a true ECN/STP broker first. Also ask them if they charge markups or not. You have to ask them about this and ask for proofs. In case they refused to give you a good answer, don’t open an account with them.

Good luck :)

Leverage, Margin, Balance, Equity, Free Margin, Margin Call And Stop Out Level In Forex Trading

I always see so many traders who trade forex, but still don’t know what margin, leverage, balance, equity, free margin and margin level are.

Margin and leverage are two important terms that are usually hard for the forex traders to understand. It is very important to understand the meaning and the importance of margin, the way they are calculated, and the role of leverage in margin.

Leverage:

Leverage is a feature offered by the broker, to help the traders to trade larger amounts of securities by having a smaller account balance. For example, when your account leverage is 100:1, you can buy $100 by paying $1. Therefore, to buy $100,000 (one lot), you should pay only $1000 (this is just an example. I know nobody pays dollar to buy dollar.

Now you tell me please. How much you have to pay to buy 10 lots USD with an account that its leverage is 50:1 ?

That is right. You have to pay $20,000 to buy 10 lots or $1,000,000 USD:

$1,000,000 / 50 = $20,000

Leverage was so easy to understand, right? I had to explain it first, to become able to talk about the other term which is margin.

Margin:

Margin is calculated based on the leverage, but to understand the margin, lets forget about the leverage for now and assume that your account is not leveraged or indeed its leverage is 1:1 

Margin is the amount of the money that participates in a position or trade. Let’s say you have a $10,000 account and you want to buy €1,000 against USD. How much US dollars do you have to pay to buy €1,000?

EUR/USD rate is currently 1.4314. It means each Euro equals $1.4314. Therefore, to buy €1,000, you have to pay $1,431.40:

€1,000 = 1000 x $1.4314

Therefore:

€1,000 = $1,431.4

If you take a 1000 EUR/USD long position (you buy €1000 against USD), $1,431.4 from your $10,000 account has to participate in this position. When you set the volume to 0.01 lot (1000 unit) and then you click on the buy button, $1,431.4 from your account will be paid to buy 1000 Euro against USD. This $1,431.4 is called margin. Now, if you close your EUR/USD position, this $1,431.4 will be released and will be back to your account balance.

Now let’s assume that your account has a 100:1 leverage. To buy 1000 Euro against USD, you have to pay 1/100 or 0.01 of the money that you had to pay when your account was not leveraged. Therefore, to buy 1000 Euro against USD, you have to pay $14.31:

$1,431.4 / 100 = $14.31

Now, please tell me that if you take a one lot EUR/USD with an account with the leverage of 100:1, how much margin will participate in the trade?

One lot EUR/USD = 100,000 Euro against USD
EUR/USD rate: 1.4314 100,000 x 1.4314 = 143,140.00 Therefore: One lot EUR =$143,140.00
$10,000 – $50 = $10,050
(200,000 x 1.4300) / 100 = $2,860.00
$10,050 – $2,859.52 = $7,190.48
($10,050 / $2,859.52) x 100 = 351.46%

Leverage: 100:1

Margin = $143,140.00 / 100 = $1,431.40

Therefore, to have a one lot EUR/USD position with a 100:1 account, $1,431.40 margin is needed.

Balance:

When you have no open position, balance is the amount of the money you have in your account. For example, when you have a $5000 account and you have no open position, your account balance is $5000.

Equity:

Equity is your account balance plus the floating profit/loss of your open positions:

Equity = Balance + Floating Profit/Loss

When you have no open position, and so no floating profit/loss, then your account equity and balance are the same.

When you have some open positions and for example they are $1,500 in profit in total, then your account equity is your account balance plus $1,500. If your positions were $1,500 in loss, then your account equity would be your account balance minus $1,500.

Free Margin:

Free margin is the difference of your account equity and the open positions’ margin:

Free Margin = Equity – Margin

When you have no position, no money from your account is used as the margin. Therefore, all the money you have in your account is free. As long as you have no position, your account equity and free margin are the same as your account balance.

Let’s say you have a $10,000 account and you have some open positions with the total margin of $900 and your positions are $400 in profit. Therefore:

Equity = $10,000 + $400 = $10,400

Free Margin = $10,400 – $900 = $9,500

Margin Level:

Margin level is the ratio of equity to margin:

Margin Level = (Equity / Margin) x 100

Margin level is very important. Brokers use it to determine whether the traders can take any new positions or not. Different brokers have different limits for the margin level, but this limit is usually 100% with most of the brokers. This limit is called Margin Call Level. 100% margin call level means if your account margin level reaches 100%, you can still close your open positions, but you cannot take any new positions. Indeed, 100% margin call level happens when your account equity equals the margin. It happens when you have losing position/positions and the market keeps on going against you and when your account equity equals the margin, you will not be able to take any new positions anymore.

Let’s say you have a $10,000 account and you have a losing position with $1000 margin. If your position goes against you and it goes to a -$9000 loss, then the equity will be $1000 ($10,000 – $9,000), which equals the margin. Therefore, the margin level will be 100%. If the margin level reaches 100%, you will not be able to take any new positions, unless the market turns around and your equity becomes greater than the margin.

But what if the market keeps on going against you?

If the market keeps on going against you, the broker will have to close your losing positions. Different brokers have different limits for this too. This limit is called Stop Out Level. For example, when the stop out level is set to 5% by a broker, the platform starts closing your losing positions automatically if your margin level reaches 5%. It starts closing from the biggest losing position.

Usually, closing one losing position will take the margin level higher than 5%, because it will release the margin of that position, and so the total used margin will go lower and therefore the margin level will go higher. The system takes the margin level higher than 5% by closing the biggest losing position first. However, if your other losing positions keep on losing and the margin level reaches 5% again, the system will close another losing position.

Why the broker closes your positions when the margin level reaches the Stop Out Level?

The reason is that the broker can not allow you to lose more than the money you have deposited in your account. The market can keep on going against you forever and the broker can not pay for this continuous loss. It makes sense, doesn’t it?

Cancelled By the Dealer:

When you have some open positions and some pending orders at the same time, and the market wants to trigger one of your pending orders while you have no enough free margin in your account, that pending order will not be triggered or will become cancelled automatically. Those trader who don’t know what “cancelled by the dealer” is complain when they see that a pending order is cancelled or not triggered. They think that the broker had not been able to carry their orders, because their liquidity providers had no enough liquidity or because the broker is a bad broker. But the the truth is that your pending orders could not be triggered or were cancelled because you had no enough free margin in your account.

There is a margin check that tests for what the MT4 account margin level will be after the trade is open, and if it is within the acceptable limits, it lets the trade through. The threshold for measuring the post-trade margin ratio is set by the broker usually at 120%, meaning that the bridge will calculate what the used margin will be in the MT4 account after the new trade opens, and if the account equity is less than 120% of the post-trade used margin, the trade will fail margin check and will be automatically cancelled by the bridge MT4 dealer accounts. Of course different brokers can have different post-trade margin ratio setting, but it is usually 120%.

How to check your account balance, equity, margin and margin level?

You can see this information by checking the MT4 terminal. Open the MT4 and press Ctrl+T. The terminal will be opened and it shows your account balance, equity, margin, free margin and margin level.

This can be different in other platforms.

Balance will change only when you close the position. The profit/loss will be added/deducted to the initial balance and the new balance will be displayed.

Balance – Floating Profit/Loss = Equity

Margin = $2,859.52

Equity – Margin = Free Margin

(Equity / Margin) x 100 = Margin Level

OK 

I hope you are not confused. It is very easy to understand. You may need to read the above explanations for a few times to completely digest the terms I explained.

Briefly and in very simple words:

Leverage: Is the bonus you receive from the broker to become able to trade large amounts with having a small amount of money in your account. When the leverage is 100:1, it means you can trade 100 times more than the money you have in your account.

Margin: Is the money that will be placed and engaged in the positions that you take. For example, to buy $1000 with the leverage of 100:1, $10 from your account will be engaged in the position ($1000 / 100 = $10). You can not use this $10 to take any other positions, as long as the position is still open. If you close the position, the $10 margin will be released.

Balance: Is the total amount of the money you have in your account before taking any position. When you have an open position and its profit/loss goes up and down as the market moves, your account balance is still the same as it was before taking the position. If you close the position, the profit/loss of the position will be added/subtracted to your account balance and the new account balance will be displayed.

Equity: Equity is your account balance plus the floating profit/loss of your open positions. For example when you have an open position which is $500 in profit while your account balance is $5000, then your account equity is $5,500. If you close this position, the $500 profit will be added to your account balance and so your account balance will become $5,500. If it was a losing position with -$500 loss, then while it was opened, your account equity would be $4,500 and if you close it, $500 will be deducted from your account balance and so your account balance will be $4,500. When you have no open positions, your account equity will be the same as your account balance.

Free Margin: Free margin is the money that is not engaged in any trade and you can use it to take more positions. You remember what the margin was, right? Free margin is the difference of the equity and margin. At the above example, your position margin is $10. Lets say the equity is $1000. Therefore, your free margin will be $990 ($1000 – $10). If your open positions make money, the more they go to profit, the greater equity you will have, and so you will have more free margin.

Margin Level: Margin level is the ratio (%) of equity to margin. For example, when the equity is $1000 and the margin is also $1000, margin level will be $1000 / $1000 = 1 or in fact 100%. If the equity was $2000, then the margin level would be 200%.

Margin Call Level: Is the level that if your margin level goes below it, you will not be able to take any new position. Margin call level is determined by the broker. When it is set to 100%, you will not be able to take any new position if your margin level reaches 100%. When you have losing positions, your margin level goes down and becomes close to the margin call level. When you have winning positions, your margin level goes up.

Stop Out Level: Is the level that if your margin level goes below it, the system starts closing your losing positions. It will close the biggest losing position first. If this helps the margin level go above the stop out level, no more position will be closed. Then if your other losing positions keep on losing and the margin level goes below the stop out level again, the system closes another losing position which is the biggest one.

Thanks for your time and have a great day/night 

What is Margin Call & Stop Out level?

QUICK SUMMARY

"Margin Call" vs "Stop Out level"

When the broker says that Margin Call = 100%,
this means that Margin Call = 100% and Stop Out level = same 100% of the Required Margin

This means that once your Account Equity = Required margin x 100% 

You’ll get a Margin Call and immediately a Stop Out, where your trading positions will be closed forcibly (one by one starting from the least profitable and until the minimum margin requirement is met).

When a broker says that Margin Call = 30% and Stop Out level = 20%, 
this means that once your Account Equity = Required margin x 30%
you'll get a Margin Call in the form of a Warning.

And when your Account Equity = Required margin x 20%
your trades will be closed automatically starting form the least profitable one.

DETAILS

"Margin Call" vs "Stop Out level"

While some Forex brokers operate only with Margin Calls, others define separate Margin Calls and Stop Out levels.

What's the difference?

Margin Call is literally a Warning from a broker that your account has slipped past the required margin in %, and that there is not enough equity (floating profits - floating losses + unused balance) on the account to support your Open trades any further.

(Speaking of trades, definitely only the losing trades will drag your account equity down, but even if you haven't accepted the losses yet, at some point you might run out of money, because your floating losses count).

Stop Out level is also a certain required margin level in %, at which a trading platform will start to automatically close trading positions (starting from the least profitable position and until the margin level requirement is met) in order to prevent further account losses into the negative territory - below 0 USD.

How does it work with different brokers?

If you see in the trading conditions something like this:

Margin Call - 30%Stop Out level - 20%

This means that when your Account Equity becomes equal 30% of the Required Margin, you'll get a warning from a broker: it can be

either a highlight on your platform, or a certain message, or an email etc. saying that your equity is now insufficient to continue trading and maintaining currently active positions; and that means that you have to either think about closing some of them or add more funds to the account to meet the minimum margin requirements.

If you don't do so in a timely manner & the market still doesn't cut any slack to your losing trades, you'll be approaching the Stop Out level - at which the system [a trading platform] will perform an automated closure of your unprofitable trades starting from the least profitable and until the minimum margin requirements are met.

If you see in the trading conditions something like this:
Margin Call - 100%
No mentioning of a Stop Out level

This means that Margin Call = Stop Out level = 100% Required Margin
When your equity slips past 100% of the Required Margin, you'll get a Margin Call & the trades will be closed forcibly in the same manner described above (starting with the least profitable one). The Warning Stage here is omitted, BUT don't be overexcited about the opportunity to get a Warning first with the 2 staged process, because a broker keeps the right to close your trades without prior notice even if it's only a Margin Call "stage".

Formulas and Examples:

To calculate the margin requirement required for every open position:

Required Margin = (Market Quote for the pair * Lots) / Leverage.

Example: You want to open 0.1 (10 000 base currency) lots of EUR/USD at the current market quote of 1.3500 and with a leverage level of 1:400

Required Margin = (1.3500 * 10 000) / 400 = $33.75

In order to open & further keep such a trade, you'll need to have at least $33.75 of the available equity on the account.

If we open 2 x 0.1 lots, the Required Margin is doubled = $67.5 and so on. The more positions you open, the higher is the requirement to keep them in the market.

Account equity = available not used in trade funds + floating profits from still open trades - floating losses from still open trades

Margin Call = Account equity has become equal to Required margin.

Pros and cons of 100% Margin Call vs lower % Margin Calls & Stop Outs

Simply put:

(+) being stopped at 100% margin saves for traders significantly more money when the losses are inevitable;
(-) being stopped at 10% margin saves only a few dollars on the doomed account.

(-) having a 100% margin requirement means that the Margin Call is looming much closer
(+) having a low 10% margin requirement puts the risks of getting a Margin call further away

(+) 100% margin requirement does the final stage money management job for you, so you won't lose your last short if you don't have the skills yet to do the proper money management yourself

(-) 10% margin requirement requires a perfect understanding and managing of the own account equity and margins.

How to avoid Margin Calls & Stop Outs?

1.       Carefully choose the leverage. If you choose a lower leverage, make sure you have sufficient funds to open and maintain trades. If you choose a higher leverage, make sure you don't open more trades than you can handle with your account equity.

2.      Reduce your risks. Control how many lots are traded at one time. Watch your account statistics for Required and Available Margin.

3.       If in doubt about meanings of the numbers in your Account, read more educational topics about the subject.

4.      Place stops to protect your equity from significant losses.

5.      If in trouble and approaching a Margin Call point:
a) try changing your leverage to a higher one
b) add more funds to the account

c). close unprofitable trades before the platform does it for you

d). hedge those trades, IF you know how to get out of the hedged trades later (requires experience)

All these measure will delay the approaching of the Margin Call, BUT you would still need to manage your losing trades before they bring any more losses.

What’s the Difference In the middle of a Market Maker and an ECN?

Market maker or ECN is the single most critical distinction between FOREX broker-dealers. A market maker, or dealer, is always the counterparty to your trades; an ECN requires an actual counter order for execution. Given the liquidity of the FOREX markets, a counter order is only a problem in a very fast or very slow market or if you place an extremely large order. An ECN cannot play many of the games that market makers do -- in large part, they do not need to because they have no book to balance. But ECN trading also requires a more accurate and delicate trading touch -- an additional skill that the trader must acquire.
Regarding market makers: some are good, even very good; many are awful.

Keep in mind what counterparty to your trade means. Then remember that market makers hold all the cards -- the data stream, the dealing desk, or control through their liquidity providers with an NDD (no dealing desk), the trading platform, and all the tools -- requoting, pip spreads, trading rules, dealer intervention, accepting or canceling trades -- all for the supposed purpose of maintaining an orderly market. National Futures Association (NFA) Compliance Rule 2-43 has minimized some of these factors -- but not eliminated them by any means. Progress is being made but continued excesses will make them the dinosaurs of the industry.

ECNs have their own issues -- In fast or slow markets, liquidity may actually be worse with an ECN because they do not have many of the orderly market tools at their disposal. But on balance, I feel that once you have gotten your feet wet in FOREX, shop for an ECN. Several retail brokers are offering ECN trading even to mini-accounts. How they bundle 10k lots into a 250k bank lot without intervention, I have not fully determined and, quite honestly, probably do not want to know.

The core issue -- and the reason the author predicted in the second edition that market makers would lose ground to ECNs -- is that market makers manipulate the books to maintain order. This involves a number of activities such as requoting, dealer intervention, and setting pip spread -- as and when they please. Market makers trade against their customers -- it is why and how they are what they are. A profit for you may well be a loss for them. What would you do with a customer who cost you money on a consistent basis? ECNs may also act as a counterparty. But here -- at least in theory -- it is supplemental to their primary duty of trade matching.

Market makers set, manipulate, or control pip spreads, usually as legitimate operations of the market-making process to maintain an orderly market; ECNs generally do not. Many trading platforms -- both market maker and ECS -- provide depth of market: the ability to see standing buy and sell orders, and the quantities and prices bid and asked. This can be valuable information if you learn how to use it properly.

To complicate matters, some firms that are obviously market makers now advertise a no dealing desk. The author is unsure how such a hybrid operates; in some instances, it appears to be nothing more than semantics in an effort to shake the market-maker moniker. Lack of regulation makes knowing how a broker-dealer processes trades difficult, if not impossible. The author queried five such brokers about this process and received no response from four of them and what can only be described as mumbo-jumbo from the other one. More and more brokers are attempting to distance themselves from the market-maker label, but whether they are actually making any significant changes to how they execute trades remains a question in many instances. All of this said, if you like to trade the minor or exotic currency pairs you will probably get a better deal from a reputable market maker than and ECN. The market maker provides liquidity to these pairs that are many times not available to the trade-matching ECN.

You will hear the term liquidity provider from both ECNs and market makers. For a market maker, it really has little meaning but it sounds good. It does not matter how many liquidity providers a broker-dealer has if it stops the feed to sniff or manipulate it before passing it through to the customer.

In reviewing the fine print of account forms, you notice that even ECNs withhold the right to intervene as market makers. Yes, it is confusing! In FOREX, ultimately, "You pay your money and you take your pick."

How to Classify a True ECN Broker

Forex is a very lucrative market and it is attracting people everyday who are eager to invest their hard earned money and make it big in short span of time.  

Due to it's high interest among public, new Forex brokers are appearing in the market continuously. 

There are countless number of Forex brokers in the trading world so choosing the right one is absolutely crucial to start your trading journey.

In my previous article, I have already stated the basic steps to choose a broker that would keep your trading safari less dreadful and help you achieve your goals without worrying about external factors. After getting useful comments from knowledgeable community members and gaining experience through research and trying out multiple brokers, I am confident that ECN brokers are way more suitable than Market Markers.

What is an ECN Broker ?

The word ECN is an abbreviation for Electronic Communications Network.

It provides a marketplace where people or organizations from different parts of the world gather to compete bid and offer against each other thus providing small spreads for traders.

It is always advisable to pick an ECN broker due to the fact that they will never trade against you like Market Makers.

Their main source of income is through "commission" so they absolutely don't care if your trades win or lose.

However, there are many brokers who claims to be an ECN broker to grab clients when they are actually not. This is a very serious cause of concern and We traders must initiate proper steps in identifying them.

This would not only help to eradicate scam brokers but will also improve your percentage of return in the long run. 

How to Identify True ECN Brokers ?

I have come across few terms that I would like to share with you all as often new traders get confused by these :-

A) True ECN 
B) ECN by Association 

C) Outright Bucketshop.

These are often used interchangeably by Forex Brokers and traders but if you know the real meaning, your life would become lot easier.

True ECN brokers offers a transparent platform where traders, banks, organizations can compete against each other by sending bids and offers. Traders get the best deal for their orders at that specified time.

ECN by Association acts as a Level 2 brokers that forms a bridge between traders and real marketplace or True ECN brokers. These types of brokers have their own in house platform and can manipulate your trades if they want.

Outright Bucketshop are simply thieves, scams who are out there to steal your money. I have only one word for you if you happen to be with them and that is "good luck" 

MODE OF IDENTIFICATION

- Most traders usually new and gullible ones never read the broker agreement that usually tells you if the broker is a True ECN or ECN by association. All regulated ECN brokers will state that as it is mandatory for them to disclose such information to their clients.

- True ECN brokers will have variable spreads. I'm sorry to tell you if any ECN broker promises to offer fixed spread then it's not a True ECN broker.

- Absolutely NO dealing Dealing Desk if it's an ECN broker. Usually Market Makers have Dealing Desk meaning they will trade against you. Tips : In order to find out if it's a dealing Desk broker open a demo account and a small real account. you will see the pip difference and how much the price varies during news.

- No restriction in setting the distance of Stop Loss or Take Profit. If a broker doesn't allow Scalpers or Day traders take your pick what would that broker be? Yes you're right. That's not an ECN broker.

- Check Forex brokers chart and your order chart. Do you see any difference any BID price? If there is no difference then bingo you're with an ECN broker.

- A True ECN broker always allow traders to place any lot of trades. You can absolutely trust me on this one. Tips : If you really want to find out if it's a True ECN broker, place a trade bigger than 5 standard lots. If the order gets rejected then it's not a True ECN broker.

- Usually True ECN brokers won't promise you big offers and discount while opening an account. Like I said before they would generate revenue through commission regardless of you win or lose your trades.

- True ECN brokers will display all pricing updates every minute as the prices are coming live from the market. Tips : Check the Platform and best would be to compare it with a demo platform as well.

All these tests can be done by anyone to distinguish a True ECN broker from a Fake ECN broker. 

So what does your ECN broker stand for? Electronic Communications Network or Electronic Con for Newbies ? 

If I have missed out on any point, feel free to add them and let me know as well. We can only make our trading journey beautiful by helping each other.

- If your Broker is giving you only negative slippages then it's not a True ECN broker. Slippage is an usual occurrence and that's pretty normal in a True ECN market. Slippage can be both positive as well as negative.

Cheers !