Discuss ECN vs DD/NDD/DMA/STP/A-B-C-book business models

[outofphase]

I have spent the past 6 weeks looking for a new broker and getting an education in what is what. So of course, I can the FPA registry, and when I see people complaining about this broker or that broker is not a true ECN broker, be that as it may, and provide some sort of explanation that makes no sense, I need to speak up.

Once and for all, people, here is what ECN means:

1- ECN is not a business model; DD or MM vs NDD and STP and DMA (even though at the retail level there is no DMA possible) are business models, the acronyms being simply another way of saying A-book, B-book, or C-book;
2- So if you trade on an IT software infrastructure running on your broker's servers that meets the minimum requirements of what an ECN is (think of an ECN as an MTF or a central limit order book exchange like the CME Futures exchange) it still does not mean that your orders are put on the A-book, or that your broker is not making a market for you;
3- think about (2) above deeply until you fully understand the implications;
4- an ECN environment allows the trader to go on the bid/offer, meaning place a buy/sell order between the spread and thus improve the spread; in other words, on an ECN you can provide and take liquidity;
5- even though (4) is true, all the volume you see on the ECN's DOM (depth-of-market) could very well originate with your broker only and not come from the other clients trading on the ECN or the LPs your broker uses to push client risk out into the real market -- > so you could have a ECN like behavior on your trading app, such as cTrader, but the actual market you are trading on is a synthetic market made by your broker, the market maker; same is true for anyone trading on Currenex since Currenex white label can be set up to be B-book only EVEN THOUGH Currenex is a software infrastructure on the backend that has been designed to work as an ECN.

So how do you know for sure you are on an ECN? Only if you can go on the offer/bid and improve the spread.

How do you know if you are on an ECN that is not a market maker's synthetic market in spite of what I just wrote in the previous sentence? --> Only if the broker is willing and can provide you with a full trade report showing the full lifecycle of each and every trade you made, including the FIX report.

In other words, if your broker always puts your orders on the A-book and sends them to its LPs to fill them, the broker's system will talk to an aggregator and matching engine that facilitates communication between all the IT systems involved using a protocol called FIX (sometimes they use a binary protocol like ITCH or OUCH--you can learn all about it here: http://www.nasdaqomx.com/technology...rketview-magazine/viewarticle?contentId=38762) and everything should be logged.

If this is the case, then your broker should be able to provide you with a full report showing where and when your order was created, and all the processing stages your order went through all the way to when the order was filled, by whom it was filled, how it was filled, and so on.

That is the only way to know your broker is not B-booking you, ie using the market maker model.

But there is 1 exception as we just saw with FXCM recently. For those who don't know, a brief recap: broker claims A-book/NDD and no market making business model; BUT in reality broker sends all client orders to 3rd party affiliated with broker, and 3rd party has total control over feed and order execution.

In this case, broker can claim he is not on the other side of the trades, and even produce a report showing this 3rd party as being the LP filling all the client orders. And yet, you are not trading in a real NDD environment; your orders are passed through directly to this 3rd party (so technically it is STP) but the 3rd party behaves like a market maker! What an irony!

Global Prime in Australia uses the same setup as all client orders go through its parent company, Gleneagle Securities, which is the counterparty to all client orders even though they make a big fuss of claiming that there are very transparent precisely because they will provide you with a FIX report. You can find this information in their legal documentation, so don't take my word for it. I mention it only to illustrate the point that there is more than 1 broker out there deceiving their clients in this way.

So, conclusion is: if you want a true and real ECN trading environment, get at least 50K and open an account with prime broker Baxter-FX, or LMAX, or get 250K to open with GAIN GTX. Dukascopy is a hybrid, meaning that the broker will take the other side of some client orders, match some client orders with another client orders (aka cross-matching, what MBTrading used to call EXN), and send some client orders STP directly to external LPs even though their software trading infrastructure is designed to behave like an ECN.

Or get even more money and open an account direct with any of the institutional ECNs.

Otherwise, the best retail traders can get is STP via a broker licensed to act only as a matched principal or sometimes as an agency broker and also when you check their licence, make sure they are not authorized to trade on their own account, which many are.

Finally, there is always the lone honest market makers, such as OANDA.

So it depends on what you need. If speed and algo/HFT is what you want, also deep liquidity, trading 10K notional up to very large sizes only limited by what's available on the market, then A-book on ECN is what you want. Of course, manual trading is also going to be OK.

Non-HFT algo, speed, deep liquidity, trading 10K notional up to very large sizes only limited by what's available on the market as in lots of volume on the DOM, then A-book with STP is OK for auto trading and manual trading.

For everything else, go with a market maker until the MM tells you that you have become too good or you trade sizes that are too large (> 10M notional) or let's you trade large sizes but execution keeps degrading because they are not properly set up to hedge your trades with the real market fast enough and at best price, at which point you know you are ready to move up to the pro level.

And regarding leverage: No A-book broker will offer anything higher than 200:1. So whatever you are told by the 400:1 and above outfits, make sure you do your homework before you talk to them. And this starts by knowing to ask the right questions.

 

[Pharaoh]

Intriguing.

One silly question. I've often heard A Book and B Book used. A meaning STP and B meaning keep all trades in house (aka bucketshop).

I haven't seen much about C Book. Is that for hybrids of some sort? Perhaps for brokers that keep trades in house and hedge themselves against an outside LP every so often?

 

[outofphase]

Intriguing.

One silly question. I've often heard A Book and B Book used. A meaning STP and B meaning keep all trades in house (aka bucketshop).

I haven't seen much about C Book. Is that for hybrids of some sort? Perhaps for brokers that keep trades in house and hedge themselves against an outside LP every so often?

There are no 'silly' questions Pharaoh as long as they help us learn.

I am gonna answer by saying this is what I learned the terms mean:

STP was initially used to referred to the administrative bookkeeping (not the trading book, but accounting) process of passing the data of every client's financial activity straight through to the backend admin IT systems for accounting related purposes (that's where Harmony's Traiana comes in, if I am not mistaken).

So STP had nothing to do with passing the trades directly through the retail broker and on to the external market where the LPs lurk since before retail SPOT FX trading existed, all the pros would be trading on institutional ECNs (FXAll, HotSpotFX, Bloomberg TradeBook, and so on...) and the institutional dealers on the interdealer market, and the banks (central and Tier 1) on the interbank market and so on.

I believe STP began meaning what it means today to the retail crowd when retail brokers realized it was time to make it clear they were not market makers. So to emphasize they would not be on the other side of each trade, they decided that Straight-Through to the LP would be good enough for marketing purposes.

Now, B-book aka systematic internalization (of client trades or flows) aka risk warehousing, and all sorts of other terminological variants is basically market making, which does not imply bucketshop, ie cheating. I would like to believe until proven otherwise, OANDA is showing the world that you can B-book clients without cheating them. In fact, OANDA has no maximum NOP per client. Let me rephrase this: There is a max trade size per one click. But theoretically, they told me that a trader (assuming enough equity) could place 100 10 (standard) lot orders in a row on any major; so 10 lots = 1M, 100 * 10 lots = 100M notional. Or more. What would happen is that if the client's aggregated trade size goes beyond OANDA's risk management capability, they just flip (or hedge) the excess volume to the outside/with one or more LPs. Execution quality is probably not gonna be the best, but there you have it. As long as they resist the temptation.... but then again, it seems the managing team at OANDA understands statistics, so why would they need to cheat clients when they don't have to? Makes no good business sense no matter which way you look at it.

A-book, I always understood as meaning an ECN central limit order book, in which case, the STP scenario really should mean the broker maintains no book at all and only pockets spreads and/or commissions.

So STP does not imply ECN. Let's make it clearer: STP is not ECN.
BUT if we are talking about a retail broker's ECN (cTrader, Dukascopy's SWFX) and not an institutional grade ECN technology (HotSpotFX, FastMatch, FXAll, FXConnect, Currenex, etc etc) we could have the following trading environment:

- What MBTrading used to call EXN, or Electronic Crossing Network, where internal client orders are matched against each other first;

- When a client order volume is larger than available liquidity on the broker's ECN and cannot be entirely filled on this ECN, then either the remaining volume is passed onto the broker's LPs (so in this case, I guess they could call that STP execution) either on an agency basis or as a matching principal, OR the part of the client order is matched against liquidity from other clients, and the part that exceeds available volume on the broker's ECN is matched against liquidity provided by the broker itself, ie the broker becomes the counterpart as in the broker's volume appears on the ECN alongside its clients and the trade stays in-house on the broker's ECN as the execution venue.

It is my understanding that that is how Dukascopy's SWFX ECN operates, essentially a hybrid model, which some people call C-booking.

The other thing is, since to be able to trade directly on an institutional ECN such as HotSpotFX, for ex, one would need to be able to come up with the required and sizeable collateral the institutional LPs require, hence individual high net wotrh pro traders at that level use a prime broker that has these necessary relationships with the LPs in place. So we see that trading on these venues (ECNs) is impossible for retail traders. So the only ECNs retail traders have access to are the likes of Dukascopy, LMAX, Currenex white label when Currenex is not set up as B-book only, with one exception (maybe more, but I only know this one): prime broker Baxter-FX will onboard you for 50K min and then you are trading on institutional ECNs.

 

[outofphase]

Damn it. Just re-read myself and spotted a few mistakes. Where is the edit button?

 

[Pharaoh]

PM the corrections to AsstMod and he'll do the repairs.

Editing only works for a few minutes after you post. Too many companies blackmailed traders into hiding information.

 

[outofphase]

PM the corrections to AsstMod and he'll do the repairs.

Editing only works for a few minutes after you post. Too many companies blackmailed traders into hiding information.

Oh really? What on earth... the blackmailing thing.

Anyways, I'll just append to my post here, which is so long I don't even feel to re-read it! But the thing I was inaccurate about is in regards to C-booking, which when some people talk about a hybrid model, other people also mention C-book as the book on which all algo trading is put. But I don't know for sure.

Also, I wish there was a way to make it clear to all the retail traders that whenever they see a broker site emphasizing 'TrueECN', well, maybe not. And certainly not because cTrader or Currenex is available--what kind of market is it if all the volume on the so-called ECN comes from the broker as the broker makes a market for its clients?

When I am bored, I actually call up various retail brokers, especially the large ones and talk to their sales guys for entertainment purposes.... and boy I got stories. You wouldn't believe how many started laughing and fessed up that the label 'TrueECN' is just on the website for marketing purposes and that at best, all trading occurs on a STP basis. At best. Think about that for a sec.

 

[outofphase]

Although the following is sourced from an article on Finance Feeds about the evolution of OTC trading in China and how it is the next frontier given the sheer size of the Chinese market, it contains interesting tidbits that help illuminate what is really going behind the scenes at most retail FX brokerages and product issuers such as CMC Markets among others (that is right, CMC is not a broker).

The first thing to understand is that to be allowed to play with the big boys, aka given access to the real market, the gatekeepers have now raised the minimum capital requirements for their clients (retail brokers, high net worth individuals, fund managers, etc), capital that is required to receive credit lines that can then be passed on to the broker's clients to trade with leverage.

Why is this a problem? Because if a broker can't get the credit lines, then it cannot place trades with a Prime Broker (PB) or Prime of Prime (PoP), let alone gain direct access to the major institutional ECNs out there: EBS, HotSpotFX, BARX, FXAll, FXConnect, Currenex, etc. This means: it can't access the real market and therefore neither can its clients.

'“Many retail brokerages do not have enough capital to be able to gain a prime brokerage agreement with a major Tier 1 bank (in many cases a minimum capital of between $50 million and $100 million has to be demonstrated to maintain a prime brokerage agreement) but on the other hand they cannot go upstream because they are unable to afford exchange clearing fees and membership.'

So where--in other words, what is the execution venue for your trades?--do retail client trades get executed? The vast majority of small and medium retail brokers will create a synthetic market, ie systematically internalize their client order flow, ie trade against it, ie act as a market maker, and manage client risk this way, fingers crossed that most clients will be losers. I say 'cross fingers' because their risk management process does not allow them properly hedge those positions in the real SPOT market due to lack of access because the broker itself is too undercapitalized and thus represents too much of a counterparty credit risk in the eyes of the institutions that are supposed to extend credit lines to it.

Others will manage to offload client trades on a pass-through fashion to a MTF (or exchange like structure) such as LMAX or a PB that is less picky, such as SAXO Bank Prime or Dukascopy Bank and gain access to liquidity that way.

In all cases, clients are not trading on an ECN, REGARDLESS of all the claims of 'TrueECN' and 'Interbank Liquidity', which is all bullshlt, but mostly on a B-book as their trades are booked internally by their broker, the broker simply using its connection to LMAX and/or SAXO Bank Prime or Dukascopy to hedge the trade it has entered into with its client.

So, I believe it is fair to say that:

1/ the potential for conflict of interest still reigns supreme in this industry.
2/ no real ECN trading conditions are available to retail traders anywhere due to the impossibility to get access to the required credit lines offered by banks/PBs/PoPs due to the lack of capitalization of the brokers themselves and of course, retail traders lack such funds even more so it's a no-starter for a retail client, BUT there are 3 exceptions I know of:

1. Baxter-FX gives access to HotSpotFX, FXAll, the A-book version of Currenex (not the B-book version) for a minimum deposit of 50K/USD.
2. LMAX gives access to its MTF (European name for ECN) for a minimum of 10K/USD, less if you go through Hungarian Broker UltraFX.
3. Dukascopy Bank (both EU subsidiary and Swiss parent company) gives access to its own developed ECN technology they call SWFX, that appears to offer the same capability as a real ECN, namely: for a client to go on the bid/offer and thus help improve the spread (ie be both as a liquidity taker or provider on the ECN for other clients), match 1 client order against another client order, see the actual volume on SWFX on a DOM (Depth-of-Market)-like graphical user interface element (what's called a 'price ladder' or Level-2 display). BUT since SWFX is 100% controlled by the broker, ie Dukascopy Bank, this also allows Dukascopy to post their own liquidity on their ECN at whatever price level they choose, in other words, create a market for specific groups of clients that have a poor win-to-loss ratio, thus enabling Dukascopy Bank to implement a hybrid business model: A-book, B-book, and C-book (for all the algos written in Java and running on their JForex platform).

If you know of any other broker offering true ECN trading conditions, or an ECN venue that onboards retail traders and not only professional or high net worth entities, please let us know. Would be interesting to find out who else offers ECN trading conditions to the retail crowd. And am not talking about the likes of ICMarkets or TradingView Forex in the Cayman Islands. Although ICMarkets is large enough that they could offer real ECN market conditions on cTrader, I am still waiting for the proof that this is the case.


source: financefeeds.com/otc-fx-is-king-in-china-local-banks-have-to-risk-100-million-to-make-50-million-in-trad-investments/

 

[outofphase]

Another great read from Finance Feeds: the title says it all. You'll find an interview with easyMarkets's CMO and Dukascopy's COO. Interesting words indeed.

source: financefeeds.com/making-b-book-cool/

 

[outofphase]

I am striking gold today. Great articles from Finance Feeds: here is another one on why any broker offering leverage greater than 100:1 is most likely using a dealing desk against its clients. Read on to find out more.

source: financefeeds.com/11000-leverage-on-ecn-accounts-yes-and-i-am-a-hobgoblin/

 

[outofphase]

Another must-read for all traders, again from Finance Feeds: They interview Natalia Hunik from Advanced Markets/Fortex and she list 4 key questions to ask any broker to get as close as possible to the truth. Read on and find more here: financefeeds.com/passing-the-bucket-is-your-pb-really-sending-orders-to-the-market-or-does-stp-stand-for-straight-to-pocket/