News

Part II: Market Maker versus STP Broker

Written by Fred Scala

I often hear people mention that they only want to deal with an STP broker: they don’t feel comfortable trading against a market maker. Back when e-trading was in its early stages brokers that employed a market maker strategy were often accused of moving prices to trigger orders that were unprofitable for their clients. On the surface the complaints made sense because the broker benefited from the clients loss and when the broker only had a few clients they may have been able to manipulate their rates. I don’t think that is so today.

Market Maker

Brokers that have a market maker business plan provide both a bid and an offer constantly. If they change their stream to affect one side of the market they will create opportunities for the other side of the market. When you have tens of thousands of clients it’s not possible to move rates to create a disadvantage for one group of clients without also creating an advantage for another set of clients.

Every market maker does have the ability and the right to express their interest. What I mean by that is if the market maker has a large short position and they are uncomfortable they may show a more aggressive bid and a less aggressive offer, as an example if the market is bid at 22 and offered at 23 this dealer may show a bid at 22.5 and an offer at 23.5. This has nothing to do with market manipulation but rather the inventory that they have built up. You may say that they are penalizing buyers who will pay a higher price but they are also providing a higher bid price to anyone with selling interest. If you choose to work with a market maker ensure that their prices are consistent with normal market spreads, you don’t want to deal with a market maker that will consistently widen their prices rather than skew their prices to show a better bid or offer.

In trading with a marker maker you will rarely have an issue with high rejects or long latency hold times. The market maker will accept your trade and manage the risk once it comes into their position.

STP Broker

STP stands for straight through processing which means a Forex broker will pass all the trading flow to their liquidity providers.  STP brokers naturally align their interests with their clients’ interests as the STP brokers profitability depends on the overall volume traded by their clients. Nevertheless, STP brokers have several downsides that are important to consider when choosing a liquidity provider.

An STP broker will be subject to higher rejection rates as their execution depends on the depth of their liquidity pool: the bigger the trade is the higher chances of rejects. Latency will always take place as it takes some time for STP broker to pass the trade to LPs and report execution back to the trader. The normal work flow of an order for an STP broker is as follows: 1) Client enters an order and sends it to the broker 2) Broker accepts the order  3)Broker passes the order to the LP with the best price available 4) LP accepts the order 5) LP confirms that the order has been executed 6) LP sends the execution message to the broker 7) broker sends the execution message to the client. Slippage in fast moving markets is another complaint that you might hear from clients trading with an STP broker. News traders will suffer most. Possibility of price adjustments is another drawback of an STP broker. If STP broker executed your trade and due to some technical issues the trade was not honored by LPs at the reported price – your price will be adjusted. The STP broker will work with their LPs and try to come up with solutions but they may not always be favorable for the client.

Whom to work with

The decision to trade with a market maker or STP broker depends on the client base of your retail brokerage company. For example if your clients are news traders then a market maker stream will suit their needs best. If your clients don’t trade in fast moving markets then you might prefer working with an STP broker. Most market makers have the ability to offer both STP and market maker streams since they have risk managers on sight and incoming streams to STP where they build their price from.

I hope I was able to offer some insight into what determines a better liquidity partner. For questions or comments please contact me at fscala@Tripeak.com

Read Part I here

Part I: Spreads, execution and latency

Written by Fred Scala

A lot of people think the tightest prices available will give them the best liquidity stream. That is not always true. Depending on your business the best stream might not have the tightest prices. When you speak with an LP about which streams might best suit your Forex business needs, remember that there are three main components of the price: spread, execution and latency. We normally say you can have two out of the three but it is very rare to have all three. If you want very tight prices you may incur higher latency or higher rejects. If fill rates are most important you may see slightly higher latency or slightly wider prices and if speed is your major concern then fill rates or spread will probably suffer.

When clients or prospects  look at a demo stream they only have access to one component of the price, the spread, they have no idea about latency or fill rates, even if the client is trading a demo account those fx trades will never go to an LP on the backend so there will never be any latency or rejects. In a demo stream all trades are confirmed as executed immediately, this is a very important point to understand. It gives you a meaningless comparison unless you are in a live environment.

In order to find the proper liquidity provider for your business you need to examine your flow and determine what factors are most important. If you have a high frequency brokerage model then latency and fill rates will be high in your ranking, if you cater to   macro traders then spreads and fill rates will be more important in your decision.

The best solution is to partner with an LP that can provide multiple streams and allow you to segregate your clients based on their needs. If you only have one stream to an LP then you will only have one solution. If you partner with an LP that can provide a tight stream for one set of clients, a stream with a high fill rate for another part of your client base and a third stream for low latency needs you will be able to segment the flow properly and avoid future issues.

I hope I was able to offer some insight into what determines a better liquidity stream and liquidity partner. If you have any further questions on this topic or other areas please contact me at fscala@Tripeak.com Read Part II here

The ability to accurately forecast revenues is a crucial tool in identifying targets for success.  Brokerages that utilize a Straight Through Processing (STP) model may calculate volume-based revenues related to total client deposits, estimated monthly trading volumes, and round turn markups.  As the number of clients increase, total deposits, trading volume, and subsequently revenues will also increase.

Consider the following example:

Total client equity deposits = USD $100,000

Estimated Monthly Trading Volumes = 500 times total equity deposit

Markup per trade = 2 pips (or $200 per million)

Using these assumptions, a brokerage can generate $10,000 revenue per month (Monthly Revenue = Total Equity Deposit * Monthly volume turnover * # pips).  The more accurate your assumptions, the better your forecasting will represent the brokerage’s ability to make profits.

This model demonstrates potential profits based on overall deposits and client trading volumes.  The better understanding of your clients’ trading activity and behavior, the more accurate your model will be.  Revenues are generated on each and every trade, regardless of price movement.  By eliminating dealing desk risk with STP trading, you can estimate revenues to help make decisions about future investments, marketing budgets, and even consider starting your own FX brokerage.

Download our Free Brokerage Revenue Calculator and learn how much revenue your brokerage business can generate during the first year.

//

At Tripeak we are often asked the question, “How do I start my own brokerage?”  When one thinks about it the process can appear quite overwhelming.  For example, if you asked someone to describe a brokerage they would probably conjure up images of a noisy trading floor in a high rise building with paper flying all over the office.  So how does one actually go from an interesting idea to a full-fledged round-the-clock business?  The truth is that just like any business, even the most successful brokerage starts with humble beginnings.  When it comes to taking this idea and turning it into reality, you might be surprised to learn that the steps required can be broken down into three categories: capital, concept, and a trustworthy partner.

The Capital

Getting a forex brokerage off the ground is no different from starting any other type of business.  You will need to have startup capital, but that alone will not be enough.  Additional funds covering the month-to-month expenses of running your business should not be overlooked.  A few costs to keep in mind are office space, payroll, accounting fees, and general office supplies such as desks and computers.

The Concept

Having the necessary capital is not all you will need if you want your brokerage to be successful.  You will need to offer something which will separate it from the rest or perhaps target a niche segment of the trading community.  The good news is that the foreign exchange (FX) market for retail traders has been growing significantly over the past 15 years.  What is even more exciting is that the forex market is by far the fastest growing market when compared to stocks or futures trading.  There is plenty of potential for growth once you have decided what your strategy will be.  Do not forget that you will also need a plan for generating interest in your brokerage, acquiring customers, and maintaining those relationships.

A Partner

Once you have the necessary capital and a business strategy you are ready to get started.  In terms of the process, it is possible to start a brokerage from the ground up without any outside assistance; however, if you choose to pursue this route it will be taxing both in terms of your time and money.  An easier option is to join forces with Tripeak as a business partner.  We offer you everything you need to turn your concept into a full-fledged brokerage.  Not only will we provide all the tools necessary to get started, you will also be able to tap into our expertise in this business.

Interested in learning more?  Our Business Intelligence team is available to answer any inquiries you might have.  Feel free to contact us!

You can also learn more about starting your own brokerage from out free business plan.

//