Performing STP: How Forex Brokers Manage Their Risk

A-Book brokers are also sometimes marketed as “STP brokers”.

But this is in fact incorrect.

While both are similar in that they transfer market risk, they are actually two different ways of executing an order.

In this lesson, we will explain the difference between running A-Book and STP.

“Straight-Through Processing” is a term often abbreviated as “STP”.

You may have seen this acronym mentioned by some forex brokers on their websites.

It is important to know that the term STP (Straight-Through Processing) has been abused by the retail forex industry and has taken on a different meaning.

Originally, STP was a term introduced when e-commerce first appeared at the time. It describes the process used by businesses to optimize the speed at which they process transactions.

E-commerce allows for “direct processing” (STP), whereby transactions entered electronically can also be processed (deleted and settled) electronically. Because STP involves no paperwork and little human intervention, errors are largely eliminated, significantly reducing operational costs and risks

. In short, STP allows the entire business process to be conducted electronically without the need for re-entry or manual intervention.

This is how STP was originally defined, but the retail forex industry later decided to be creative in its use.

Today it is used as a marketing jargon to imply that a forex broker does not 'touch' or interfere with your positions, nor profit from your losses, as it is supposed to 'route (or send) your order directly at the market'.

As you know, your order is never routed or sent to the “market” because the forex broker is your only counterparty and always has the opposite view of your trade.

Let's see how the “STP” runtime actually works.

A-Book vs STP

Sometimes a transaction that is “A-Booked” is combined with “STPed or simply ”STP.

Forex brokers may use them interchangeably in their marketing, but they are NOT the same.

It is important to distinguish between the two concepts.

· STP is known as “pre-trade hedging”.

· A-Book is called “post-trade hedging”.

Depending on whether your broker is an “A-Book broker” or an “STP broker”, your experience with how your orders are executed will vary.

With the A-book broker, you will benefit from faster order execution and minimal slippage.

This is because the broker will execute your trade first and then protect itself. Hence why it is called “post-trade hedging”.

With an STP broker, you will find slower order execution and higher slippage.

Indeed, the broker will make sure to first “lock” its respective order to the LP, and then execute your order. Hence why it is called “pre-trade hedging”.

When your broker executes a clearing position with a counterparty BEFORE executing your order, this is called “straight processing” or “STP”.

Why would a broker place orders in “STP” instead of “A-Booking”？

The advantage of dealing directly with the broker is that it eliminates the slippage between the execution of the client's orders and the covered trade.

Slippage (or slippage of price) refers to the difference between the PROJECT price before an order is executed and the ACTUAL price at which the order is executed.

In trading parlance, slippage refers to the difference between the ask price and the actual price an order is executed.

Slippage usually occurs at times of economic news or announcements and the market is highly volatile and can be positive or negative.

In a rapidly changing market and/or in the event of a delay in order execution, the price you offer may no longer be valid once your order is executed. The difference between these two prices is often referred to as “slipping”.

In the event of slippage, your broker does not give you a price. Otherwise, your order will be executed at the price in effect at the time it was received, regardless of which direction the market has moved.

Sliding is symmetrical. This means that experiencing a slippage is likely to your advantage or disadvantage.

To prevent an order's strike price from slipping too far from your expected price, most brokers allow you to include a “limit” with your market or entry order.

In this case, your order will not be executed if the price at the time of receiving your order is outside the specified limit.

For example, if a broker offers you a buy (ask) EUR/USD price of 1.1000, they want to make sure they can buy EUR/USD at a lower price with an LP, such as 1.0999.

The STP allows the broker to ensure that he can “guarantee” this price before confirming his order with you. On the contrary, if he doesn't, he could LOSE money trading hedges!

But when the possibility of slippage for the broker is eliminated, the possibility of slippage for YOU (the client) has increased.

If the confirmed price with LP is different from what you submitted, this is the price at which your order will execute, possibly better (“positive slip”) or worse (“negative slip”) than what you expect.

The execution speed is slower because before the broker can confirm your trade, they have to FIRST get confirmation from their LP about their transaction.

During this process, it is possible that the price has changed and the price confirmed between the broker and the LP has changed. If so, this is the price at which YOUR trade with your broker will be executed.

This is what causes price slippage.

When an STP broker accepts an “order” from a customer, the broker is deemed to be “working” on that order, indicating a willingness to try, but not commit to, the transaction translated at the price requested by the customer.

Here is a comparison of different types of order execution:

Risk-free principle

When a transaction is made through the STP, this type of transaction is referred to as a “risk-free base” or “matched parent” transaction.

What is a “principal”？

“Principal person” is a party to a transaction. For example, buyer and seller. It's basically a fancy word for 'counterparty'.

Remember that your forex broker always does the opposite of your trade. When you buy, he sells you. And when you sell, he buys from you.

It is the single partner for all your transactions.

This is called the “main” transaction.

The forex broker, as your counterparty (principal), exposes itself to market risk, as youve already taught.

A “riskless principal” transaction is achievable with STP execution.

When you make an order with a STP broker, it instantly attempts to issue a similar transaction with an external liquidity source (a “back-to-order back”).

The broker opens (or closes) the door on your account after this “back-to-back” order is matched or filled in full.

This is how it can act as a “risk-free principal” for every trade opened or closed on your account.

A broker acts as a risk-free investor because when you submit your order:

· He first buys from an external liquidity provider on his own account (as principal), then

· Record this transaction in its own transaction book, then

· More or less will sell to you right away (as well as principal),

· Either at the same price (with “commission”) or increased (no commission).

As a result there are TWO transactions:

· One between you and the original trader risk-free (forex broker)

· One between the risk-free principal (forex broker) and the “market” (third party LP).

Example: a broker receives an order from a customer to buy 100,000 units of GBP/USD at the current market price of 1.4000; it will immediately buy 100,000 units from a third party liquidity provider (LP).

Since both trades are executed at the same price (excluding any previously disclosed price increases, fees or commissions) this will be considered a risk-free master trade.

As you can see, your trade with the broker and the broker's trade with the LP match. Hence the term “matching principal”.

The concepts of “risk-free principal” and “proper principal” are important to know as it is the closest thing a forex “broker” can do to act like a real broker.

They can 'act' like a broker by being a risk-free agent, but unlike a real broker or agent, who only acts as a matchmaker by creating conditions for transactions between two separate partners, the risk-free originator is always your counterparty.

Agent vs Key Transaction: In an agency transaction, you act as an agent for the client and do NOT participate in the transaction. You just need to create conditions. This is what real brokers do. In the main transaction, you act as the main trader and participate in the transaction. You are the seller of the buyer ... and the buyer of the seller. This is what resellers do.

When you enter a market order on your broker's trading platform, it still goes against your trade, but it acts as a risk-free principal by also participating in offsetting trades with you and the external liquidity provider.

Your broker makes money by adding a tick to the price offered by the liquidity provider and/or charging you a commission.

This means it generates trading income based on trading volume, not trading profit or loss.

It doesn't expose itself to market risk, which means it doesn't profit when you lose. The only income he earns from completing your order is from a commission or previously disclosed price.

Brokers that operate in this way are called “primary risk” or “primary matched” brokers.

You can check if your broker is a broker by checking their registration list on their regulator's website.