There are so many articles about brokers, market maker and ECN/STP brokers, liquidity providers and… already published on this site. Although I believe novice traders can read those articles and learn about these important topics, still it seems one more article is needed to explain how to differentiate a market maker from an ECN/STP one.
In the past, most traders knew nothing about the market maker and dealing desk topics, and also true ECN/STP brokers. But now that traders have learned what these systems are, they insist to open their live accounts with true ECN/STP brokers. This has caused many of the market maker brokers to pretend to be ECN/STP, whereas they are market makers, behind the scene. How can you verify this before you open a live account with a broker?
Before I answer this question, please let me give you a short explanation about market maker and ECN/STP systems. As I mentioned, there are detailed articles on this topic on LuckScout that you can read to learn more.
When you open a live account with a market maker broker, indeed you are trading with the broker, not with the real world wide currency market. The market is the broker itself. Although prices are almost the same as other brokers, on a market maker platform, your orders never go beyond the brokers computers and you trade inside the brokerage firm. So, if you make profit, the broker has to pay it. And, the money you lose goes to the broker’s pocket. It means your profit is the broker’s loss, and visa versa. Read this article to know how a market maker broker makes money: Market Maker Brokers: Is It Bad or Illegal to Be a Market Maker?
Unlike market maker brokers, true ECN/STP brokers just route your orders to the banks that are also known as liquidity providers. They just connect the platform you install on your computer to the liquidity providers computers. They charge you some fees to do that, but they don’t make any money from your losses, nor do they lose if you make profit. Read this article to learn about liquidity providers and the way they make money: How Do the Liquidity Providers Make Money and Are They Market Maker?
A market maker broker doesn’t become happy if you make profit. A consistently profitable trader is their biggest enemy, because the profit they make has to be paid from the broker’s pocket. Although more than 95% of traders lose on their own and brokers don’t have to make them lose, still most market maker brokers do their best to make the clients lose easier and earn harder. There are so ways to do that: 6 Ways Forex Brokers Cheat You
Unlike market maker brokers, true ECN/STP brokers don’t bother to make the traders lose, because it doesn’t make any difference for them. Indeed, most of them even help their clients to make profit and grow their accounts, because they will stay with the broker longer and will make bigger positions, and this means more money for the broker too.
Therefore, traders prefer to open their accounts with true ECN/STP brokers, because they don’t want to be cheated by market maker brokers. The problem is, nowadays many market maker brokers claim to be ECN/STP. Some of them even transfer your orders to a so called liquidity provider, but the problem is the liquidity provider is either another market maker brokerage belonged to the same company or a sister company, or, it is a poor bank somewhere in the Pacific ocean.
That is why I use the term “True ECN/STP” because there are “False ECN/STP” brokers too.
It is not bad and illegal to be a market maker broker. What is bad (or maybe illegal depend on who writes the rules) is to try to make the traders lose. Market maker brokers can make a huge amount of money because more than 95% of the traders lose on their own without having to make them lose. They even lose with the demo accounts too. However, the problem comes when market maker brokers get greedy and try to make more money within a shorter time. So they manipulate all traders’ positions, no matter if they are winning or losing traders. Of course, they do their best to stop the winning traders and make them close their account and leave.
You are following us on LuckScout to become profitable Forex traders. Many of you have become profitable demo traders already as per the program you are following on LuckScout (read this). However, you are worried about the broker you will open your live account with, when you are ready to. Unfortunately, we don’t refer anybody to any broker. Brokers email us on a daily basis and send tempting offers to refer LuckScout users to them to open live accounts, but we don’t even bother to answer them.
The reason is that past performance is not a guarantee of future results. Even if a broker has been doing good for years, they can change overnight and start cheating their clients, and we will be accused as the referrer too. So, although it makes a lot of money, we prefer not to enter such a game at all. However, still we can educate people to enable them to distinguish between bad (market maker) and good (true ecn/stp) brokers, so they can easily choose a good broker to open their live accounts with, when they are ready to.
The Differences of Market Maker and True ECN/STP Brokers
Fortunately, it is not that hard to distinguish between market maker and true ecn/stp brokers, even before opening a live account with them. There are some signs that you have to follow and come to this conclusion whether the broker is a market maker, false ECN/STP or true ECN/STP.
Traders like to pay less spread to make more profit. So, there is a competition among brokers to offer the lowest possible spread to attract more traders. Market maker brokers have full control on the spread. They can offer even zero spread, because everything can be set at their side. False ECN/STP brokers can do that also, because their liquidity providers are usually under their control too. True ECN/STP brokers have no control on the spread, because it is the liquidity provider that charges the spread. True ECN/STP brokers can add markups to the spread, but they cannot take it below what the liquidity providers offer.
Therefore, all the brokers who offer a fixed or zero spread are market makers. This is the first signal you have to notice. Spread cannot be fixed on the real currency market.
Also, brokers that offer higher than usual spreads are market makers, because nowadays liquidity providers offer very low spread. For example, EUR/USD spread is sometimes even below 0.6 pips. So, a broker that offers the minimum spread of 2 pips or higher for EUR/USD is either market maker or a cheater ECN/STP that has added to the spread without informing the clients.
Commission is the only known legal way for the ECN/STP brokers to make money. Markups and adding to the spread is fraud.
Swap can also be fully controlled by market maker brokers. Indeed, market maker brokers can control everything, from the price, to spread, swap, market open/close time and… .
If a broker is offering a swap free account, it is a market maker broker definitely. There is no real liquidity provider that doesn’t charge any swap. It is one of their sources of income that they cannot ignore, because they also have to pay it to the other dealer and organizations they are dealing with.
Also, when swap is exceptionally high or low, the broker is market maker.
Please note that although swap has a special formula that uses the same interest rate for calculations, different liquidity providers offer different swap, because they can control it.
3. Lot size:
I have never seen a real, well-known and strong liquidity provider like Bank of America, Nomura, Goldman Sachs, Deutsche Bank, Citi Bank, JP Morgan, Royal Bank, HSBC and… that supports micro-lots (0.01). Therefore, brokers that offer micro-lots are either market maker, or false ECN/STP.
100:1 is the maximum leverage that well-known and strong liquidity providers support. Therefore, all brokers that offer a higher leverage are either market maker or false ECN/STP.
Another thing about leverage is that some brokers lower the leverage on weekends. They say they do it to protect the clients funds, whereas this is nonsense. They do it to make all the accounts that have negative positions, reach the stop out level and get wiped out. Any broker that changes the leverage is market maker or a false ECN/STP.
Those are the most important factors that you have to check with the brokers. Hope I have not missed anything here. Please let me know if there is anything else that I have to explain.
True ECN/STP brokers don’t care how you trade and make money and how early you close your positions. They allow you to scalp and you can do it if the markets allow you to. You can use scalping robots on your platform with true ECN/STP brokers. But market maker brokers are against scalping, because they don’t want you to make small profits. Therefore, they make limits on taking profit and closing the positions. They don’t allow you to close your positions too fast. When you see such limits, you should know that you are dealing with a market maker broker.
6. Stop Loss, Target and Trailing Stop Loss:
Market maker brokers have limits on stop loss, target and trailing stop loss size. They don’t allow you to set them too tight. But true ECN/STP brokers don’t care about these things at all.
Bonus is another important sign that the broker is market maker!
I see that some brokers offer even a 50% bonus. Do you think a true ECN/STP broker who only makes money through commissions can afford to do this? They cannot afford it, even if they make extra money through markups.
Stay away from brokers who offer free bonus. They do it to attract small retail traders who don’t have enough money to open a reasonable account. And, they know that greed will make these trader to lose all. Losing the bonus doesn’t hurt the broker, because it is nothing but a number for a market maker broker. It is only the trader who loses his capital.
8. Negative Balance Protection
It is another trick by some market maker brokers. A true ECN/STP broker deals with real money. If a huge and sudden price movement occurs like the 15th Jan CHF Tsunami, and traders accounts go to negative balance because of having no stop loss or because the stop loss orders could not be triggered, then it is the traders’ responsibility to pay for the negative balance. It is your account and you are the one who have lost money, because of the currency you have been trading.
However, I have never seen that brokers prosecute retail traders for their negative balance, because if they say it in advance that it is the trader who has to pay for a negative balance, then no trader dares to sign up for an account, because not only you can lose your trading capital, but you have to pay extra for the negative balance. As far as I know, true ECN/STP brokers take the responsibility themselves and pay the negative balance to the liquidity providers. They have to shut down the brokerage if they cannot do it, and they are the one who will be prosecuted by the liquidity providers.
With the market maker brokers, a billion dollar negative balance on a live account is the same as a billion dollar loss on a demo account. Do you pay any money to the broker when you blow up your demo account? Definitely not. You just sign up for another demo account. Then why do some market maker broker offer “negative balance protection”?
This is to deceive the traders. They want the traders to feel safe. Traders don’t know what is behind the scene. So, they prefer to sign up for an account with a broker that offers negative balance protection, whereas they don’t know that such a broker is a market maker who makes them lose, but other brokers who cannot offer negative balance protection are true ECN/STP that becomes even happier if the clients make money.
Does it mean that you have to sign up for an account with a true ECN/STP broker that doesn’t offer negative balance protection? Then what happens if a strong movement occurs and your account goes to a negative balance? Read this article to receive the answer of these questions: The Swiss Franc Tsunami
Forex Trading through Real ECN/STP Brokers
Trading through ECN/STP brokers is the best option retail traders have. So far, we have published several articles about market maker and ECN/STP brokers, the differences they have and the reasons it is better to sign up for a live account with a true ECN/STP broker.
Trading through an ECN/STP broker is not like demo trading. It is trading with the real world wide currency market. I am going to explain about the facts that you will be faced with when trading through ECN/STP brokers. Please note that by “ECN/STP broker” I mean “True ECN/STP broker”, not the false and fake ones: The Difference of True and False ECN/STP Brokers
ECN/STP brokers route the traders orders to interbanks, also known as liquidity providers. So, ECN/STP brokers are nothing but mediators. They charge a small fee for each transaction. This small fee is the only legal and legitimate source of income that ECN/STP brokers have.
Unlike ECN/STP brokers, market maker brokers don’t route or transfer the traders orders to any third party. Trading with a market maker broker is exactly like demo trading, but trading through ECN/STP brokers is completely different.
Under the Market Normal Condition
1. Entry Price:
An ECN/STP broker transfers your order to a liquidity provider when you click on the buy or sell button. That liquidity provider accepts and executes your order at their own price, not necessarily the price you had on the platform when you clicked on the buy/sell buttons.
That liquidity provider price is usually different from your platform price, for two reasons: 1) They are connected to different price resources. Although prices are usually so close to each other, still there is a difference. Under the normal market condition, this difference is not more than a few pips usually. 2) Although the process of transferring your orders to liquidity providers is done automatically and electronically, it still takes some time to be done. Prices change all the time, and so, the price can be different by the time the liquidity provider receives your order.
This entry price difference is something completely normal when you trade with the real currency market through an ECN/STP broker. Novice traders who don’t have any live trading experience complain about this price difference, and sometimes they go ahead of themselves and file negative reviews on different sites.
Live and real trading through a true ECN/STP broker is different from demo trading. You have to send a request, and your requests have to be received, approved and executed. You cannot expect this to be done with your requested price. This is impossible.
This entry price difference is still much better than the difference you will experience when trading through some market maker brokers. Although they don’t route your orders anywhere, and all orders stay on the their servers, exactly like demo trading, some of them slip the price to make you enter the market with a price which is a few pips against your requested price (for example, you click on the buy button when the buy price is 1.1176, but your position will be taken at 1.1179 which is 3 pips higher. Even if you win in this position, that 3 pips plus the spread and swap will go directly to the broker’s pocket).
However, the price difference you will experience with an ECN/STP broker is not always against you. It is sometimes in your favor and sometimes against you, because it is based on the normal price differences, not intentional manipulations.
2. Exit Price:
It is almost the same with the exit price when you click on the close button. Your exit price will be different from the price you see on the platform when you click on the close button. This difference is normal with ECN/STP brokers. It is not always against you. Sometimes it is in your favor. However, market maker brokers who slip the price when you want to get in, also slip the price when you want to get out. This slippage is always against you.
When you set a stop loss and target order for a position, then, under the normal condition and in most cases the positions will be closed with the price which is too close to the stop loss or target order prices, unless the market is too volatile because of the news release (I will talk about this condition later).
Some ECN/STP brokers don’t let the liquidity providers know the stop loss and target orders. They have it at their own side, and when the price reaches the stop loss or target level, they send a closing request to the liquidity provider. In this case, the close price difference can be larger compared to the case that the stop loss and target orders are placed with the position that the liquidity provider is handling. The reason is the market volatility and the time that it takes to send the closing request to the liquidity provider, and the time the liquidity provider needs to receive and execute the request.
3. Pending Orders:
Like stop loss and target orders, some brokers place the pending orders with the liquidity providers, and some brokers hold the orders on their own servers. When the price reaches the pending orders value, they send the request to the liquidity providers. For the reasons I already explained above, with the first method, the entry price will be closer to the pending order value, but with the second method the difference will be larger. In both cases, it cannot be exactly the same, like what you see with a demo account under the market’s normal condition.
This difference is absolutely normal and is not more than 1-2 pips under the market’s normal condition. Again, the good thing is that when you trade through an ECN/STP broker, the entry price difference is not always against you.
Many market maker brokers slip the price when you want to enter the market through a pending order. This slippage is always against you. If you complain, they will answer that it is impossible to enter the market exactly with the desired price in live and real trading, whereas this is a joke, because there is no real market when you trade through a market maker broker. It is just the broker at the other side of the line.
4. Negative Balance:
Sometimes when the price moves very fast and the market becomes too validate, and at the same time the liquidity providers get bombarded with too many orders, it becomes impossible to execute the stop loss and target orders. It also becomes impossible to close the positions of the accounts that reach the margin call and stop out levels. The broker sends the request to the liquidity provider, but they cannot process it. It is the same when the order is already placed with the liquidity provider.
Therefore, some accounts that have no enough money to handle the negative positions, will have a negative balance when the liquidity provider succeeds to close the positions finally. The broker will not receive any warning from the liquidity provider if it still has enough money in the account it has with the liquidity provider. However, sometimes even the broker account reaches the stop out level and even gets a negative balance.
In both cases, the liquidity providers knows the broker as the responsible. It is the broker who has to pay the negative balance. But it is the trader who has to pay for his account’s negative balance to the broker. It is real trading after all, and each side is responsible for his own actions. You trade and you are responsible for the money you lose.
If the broker cannot pay for the losses, it can be prosecuted by the liquidity provider. And, it is the broker’s right to prosecute the client for the negative balance. The broker has to pay it to the liquidity provider, and you have to pay the broker.
Negative balance also occurs when you trade with market maker brokers. But to them, the negative balance is just a negative number. It doesn’t mean any money, and it has no value. Exactly like in demo accounts that $1,000,000 and $1 are the same and they both have no value. In spite of this, market maker brokers play a game and warn the traders to pay the negative balance, but when they see it can cause the traders to walk away and stop trading, they “generously” forgive the clients and recover the negative balances, to make the clients top up their accounts and keep on trading with them.
Some of them claim that they have something called “negative balance protection”. This has become more common since the 15th January CHF Tsunami. They claim that their “negative balance protection” works like an insurance for the traders. Whereas this is all nothing, but a dirty trick to attract the traders who don’t know what is behind the scene. People think that they are protected and nobody will prosecute them if something like 15th January CHF Tsunami happens again. So they sign up for a live account with that broker with peace of mind. The market maker broker attracts more money, whereas it is the ECN/STP broker who is the real participant of the Forex market. ECN/STP brokers cannot offer any “negative balance protection”, because it doesn’t make sense to do that.
Now the question is whether you will get into trouble because of a negative balance if you trade through an ECN/STP broker?
First of all, events like the 15th January CHF Tsunami are not going to happen even once every 10 or 20 years. It is possible that we never experience such an event again.
Second, although you will be responsible for your account negative balance, and the broker has the right to prosecute you because of it, I have never heard that they do this with the retail traders. They have to prosecute each trader who has a negative balance, take him to court and prove that he has to pay for it. It will be too hard and expensive for the broker. Even if they can do that and get the court order to take the money from the clients, they will not be able to do it, because in most cases it is somehow impossible. They have to hire a collection company to do it for them. This will cost more money for them. Besides, the collection companies don’t have enough authority to take the money from traders.
So, brokers prefer to take no action. Some of them will have to get out of this business because of the money they have lost. Many others will come to an agreement with the liquidity providers who also have lost money, but still need the brokers to make money: How Do the Liquidity Providers Make Money?
So there is nothing to be worried about.
In spite of this risk, professional traders still prefer to trade with ECN/STP, not market maker brokers, because ECN/STP brokers never cause them to lose money, but market maker brokers do. A market maker broker can never tolerate a consistently profitable trader. They want the losing traders only.
Under the Market Too Volatile Condition
What I explained above about the entry and exit prices and the differences you will experience, is true even under the market’s normal condition. However, sometimes markets become too volatile because of a big transaction or an important news release. It is when it becomes harder for the liquidity providers to execute the orders.
When you place a pending order and the price starts moving toward a special direction very strongly, reaches and goes beyond your order level very fast, then the liquidity provider cannot execute your order at the level it was set to. However, your orders will have to stay on a line, waiting for execution. Under such a condition, at any price that your order becomes executed, your entry will be the price which is in liquidity provider’s favor, not you.
For example, you set a buy pending order at 1.1187 while the price is below this level (buy stop order). Then the liquidity provider executes your order at 1.1500 which is about 325 pips above your pending order value, then your position entry will be 1.1500, not 1.1187.
Now, let’s say the price reaches 1.1187, but the liquidity provider cannot execute it there. However, instead of going up the price goes down after that while your order is on the line, waiting to be executed. Finally the liquidity provider executes your order when the price is at 1.1087 which is 100 pips better for you (it is 100 pips below your buy stop order level). In spite of this, your entry price will be considered at 1.1187 which is where you had set your buy pending order, not at 1.1087 which is the price the market had when your order was triggered.
It is the same with the stop loss and target orders.
There is the same problem when you click on the buy/sell buttons while the markets are too volatile and the price is moving too fast. However, in this case you usually get “off-quote” error and you will not enter the market. You will get this error even with a demo account when the price is moving too fast.
The above events occur on the shorter time frames and for those who trade them using pending orders.
The solution is that you don’t set any pending orders and you don’t enter the markets when a strong news is about to be released. You wait for the strong time frames to form strong trade setups, and you enter the markets when they are calm and quiet.
When you take the too strong time frames signals, then they are usually agreeable to the direction that the strong news move the price. So, you will be at the safe side most of the time, and the strong price movements caused by the strong news, will make money for you.
The way that liquidity providers behave under the markets too volatile conditions may not look fair to you, but market maker brokers will be even more brutal to traders when the market condition is not normal. You can easily make money consistently with ECN/STP brokers without having to be worried about any of the problems I explained above, whereas a market maker broker doesn’t let you make profit consistently. When they see they cannot stop you from making money, they will email you that they are not able to offer their services to you anymore, and so, you must withdraw your capital and close your account.
The Leverage True ECN/STP Brokers Can Offer
100:1 is the maximum leverage that liquidity providers offer to the true ECN/STP brokers. What happens if a true ECN/STP broker offers a higher leverage, like 500:1, to its clients? How the orders will be handled then, and who will be the loser or winner if this leverage difference causes any losses or gains?
What happens if a true ECN/STP broker offers a lower leverage, like 50:1, to its clients?
To answer the above questions, you have to know about the true ECN/STP brokers and Liquidity Providers relationship first.
There are a few things that you have to know, to become able to answer the above questions:
1. Liquidity providers only know the brokers, and from a liquidity provider’s point of view, it is the broker who takes positions with the liquidity provider, not the broker’s clients who are retail Forex traders.
2. 100:1 is the maximum leverage that strong liquidity providers offer.
What does a 100:1 leverage mean?
It means in each position, the trader pays one part and the broker or liquidity providers pays 99 parts. For example, when there is no leverage offered by the broker, and so the leverage is 1:1 indeed, if you want to buy one standard lot (100,000 unit) of EUR/USD while EUR/USD price (rate) is 1.1134, then you will need to pay $111,340 as the margin. It means, $111,340 will be hold from your account as the margin of a one lot EUR/USD position. However, when the leverage is 100:1, then only 1/100 of this money, which is $1113.40, will be on hold as margin. To learn more about this topic, please read this article. Also, here is a margin calculator.
When you take a position and the price moves accordingly and you make profit, then you can hold it as long as you want. Neither you, nor your true ECN/STP Broker and liquidity are losing money because of this position.
What will happen if a position goes against you?
When the position has a proper stop loss, it will close the position when the price reaches the stop loss level. When the price reaches the stop loss level, either the broker sends a closing request to the liquidity provider, or the liquidity provider already has the stop loss level and will close the position.
What will happen when no stop loss is set? How long can a losing position be open to lose money? What if the trader never closes the position manually?
Naturally, the position can be left open as long as there is money in the trader’s account, because if the position loses more, then the account balance will become negative, which is usually the broker’s loss and traders never pay it. So the broker has to close the position when the trader’s account runs out of money because of a losing position. To do that, there is a broker side settings which is called stop out level.
When the account reaches the stop out level, the system should close your losing position(s). Usually, brokers set the stop out level to 5%. It is a broker side settings. When you want to open an account, you have to ask your broker about the margin call and stop out levels.
A 5% stop out level is a level that if the margin level goes below it, the system will close the negative positions. Margin level is the ratio (%) of equity to margin.
Let’s say you have a $3000 account and you take a one lot EUR/USD position while the leverage is 100:1. So, a $1113.40 margin is needed for this position.
When the position is at breakeven (entry price) and so the profit/loss is $0, then your margin level is $3000/$1113.40 which is 269%. Now, let’s say the position goes against you and goes to a -$2,944.33 loss. Then your account equity will be $55.67, and your margin level will be 5%:
Equity: $3000 – $2,944.33 = $55.67
Margin Level: $55.67 / $1113.40 = 0.05 or 5%
When your position’s loss reaches -$2,944.33, then the system should close the position immediately, before the position loses more.
As I already explained, liquidity provider only knows the broker and the positions it takes. It knows nothing about the traders who are the broker’s clients. In spite of this, as each trader has a different account balance, then their losing positions have to be treated differently. In the above example, if the account was bigger than $3000, for example if it was a $5000 account, the one lot EUR/USD position could still remain open.
Although liquidity providers don’t know the traders accounts, and they only know the broker, but they sill have to know how long each position can be left open. Therefore, with each position that the true ECN/STP broker routes to the liquidity provider, it has to send some other information. One of them is the leverage that the broker has offered to the owner of each position (which can be 100:1 maximum). The other one is situation of the account that owns the position. The liquidity provider has to know each account’s current balance and equity, because it has to know when an account reaches the stop out level to close the positions.
Managing the losing positions will be very easy for the broker if it allows the liquidity providers to have access to the accounts information. If it doesn’t, then it is the broker who has to take care of the losing positions and closes them (sends a close request to the liquidity provider) when an account reaches the stop out level. That can be risky for the broker when the market becomes too volatile and the liquidity providers receive too many requests at the same time. Therefore, true ECN/STP brokers prefer to set the system in a way that liquidity providers know the accounts current balance and equity, as well as the margin call and stop out levels settings, and also the leverage that is offered to each trader’s account. Liquidity providers need these information to manage the losing positions. They don’t care about the traders personal information like name and address. Only the broker has the traders personal information.
We are getting closer to the answer of our question 🙂
I have to repeat again that 100:1 is the maximum leverage that liquidity providers offer to the brokers. So, a true ECN/STP broker who allows the liquidity providers to take care of the losing positions by allowing them to have access to the information they need, cannot offer a higher than 100:1 leverage to traders, because liquidity providers know their own limits and they are the ones who hold and manage the open positions. If a broker sends a signal which is above the liquidity provider’s limit, it will be ignored. Liquidity providers treat the positions based on the 100:1 leverage. It doesn’t care that broker has offered a higher leverage to an account. So, when an account reaches the stop out level based on the 100:1 leverage, the liquidity provider closes the position.
Offering a higher than 100:1 leverage by a true ECN/STP broker is a technical error from the broker side. Broker can offer any leverage that it wants, but when it is a true ECN/STP broker, the positions it routes to the liquidity providers will be treated based on 100:1 leverage maximum. So, if a true ECN/STP broker offers a higher leverage to its clients, for example 500:1, and then routes the orders to the liquidity provider, they will treat the positions based on the maximum leverage they support (which is 100:1), and will close the positions when the related accounts reach the stop out level, whereas from the traders point of view, the positions still have to be left open, because the accounts have a 500:1 leverage and have not reached the stop out levels yet.
So, the broker has to keep the positions open at its own side, while they are already closed by the liquidity provider, because from the liquidity provider point of view, those accounts have reached the stop out levels, but from the traders point of view, their accounts still have a long way to reach the stop out level because their leverage is 500:1.
For a one lot EUR/USD position, a $1113.40 margin is needed when the leverage is 100:1, but this margin will be 5 times smaller ($222.68) when the leverage is 500:1.
Let’s get back to the above $3000 account example. It reached the 5% stop out level after losing $2,944.33 in its one lot EUR/USD position, while the leverage was 100:1. What if the leverage is 500:1?
As I mentioned, the position has to remain open. It has to lose more to reach the 5% stop out level, because the required margin for one lot EUR/USD position is $222.68 when the leverage is 500:1. It reaches the stop out level when the position loses $2,988.87 which is a $44.54 more loss.
The liquidity provider closed the position when it lost $2,944.33, but the broker has to close it when it loses $2,988.87.
This $44.54 is the broker’s profit, because when the trader sends $3000 to a true ECN/STP broker, indeed the broker has to deposit this money to the account it has with the liquidity provider. In the above example, $2,944.33 of this $3000 is lost in a position, whereas the trader has lost $2,988.87 in reality which is $44.54 more. The trader has lost this money to the broker, because the main position was closed by the liquidity provider and the position that was open, was a fake position.
However, the story doesn’t always end with the broker’s extra profit. Let’s look at the other side of this coin:
What if the market turns around and the losing position goes to profit, after the liquidity provider closed the position???
It is the Forex market and anything is possible. A -$2,944.33 losing position can change to a +$2000 position within few hours. When the main position is closed by the liquidity provider because the account reached the stop out level, the responsibility of the position that remains open is with the broker, because the trader doesn’t know what is going on behind the scene. He believes in what he sees on his account, and what he sees is a positive position. If he closes this position with profit, it is the broker who has to pay the profit. So that profit will be the broker’s loss, whereas if the leverage was 100:1 and the position was not closed by the liquidity provider, the broker could easily withdraw this profit from the account it has with the liquidity provider.
That was the answer of the first two questions. Now the answer of the third question:
If a broker who receives a 100:1 leverage from liquidity providers, offers a lower leverage, for example 50:1, to its clients, then it has to close the losing positions when the accounts reach the stop out level based on the 50:1 leverage. The broker has to do it on its own, unless they allow the liquidity provider to know that the accounts leverage is 50:1, and so the liquidity provider closes the positions when they reach the stop out level based on the 50:1 leverage.
If the broker doesn’t close the losing positions through one of the above ways, then the platform system closes the clients positions based on the 50:1 leverage, whereas they remain open with the liquidity provider, if the leverage is 100:1 at the liquidity provider side. This can be ended to the broker’s loss again, because it is the broker who has to pay, if the position loses more with the liquidity provider while the trader position is already closed with a smaller loss.
So, true ECN/STP broker have to be careful not to offer a different leverage to the clients, either intentionally or by mistake. It can cost them a lot.