STP Execution: How Forex Brokers Manage Their Risk

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

But that’s actually inaccurate.

While they’re both similar in the sense that they both transfer market risk, they are actually two different ways to execute an order.

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

Straight-Through Processing” is a term that is commonly shortened to “STP”.

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

It’s important to know that the term STP (Straight-Through Processing) has been hijacked by the retail forex trading industry and given a different meaning.

Originally, STP  was a term introduced when electronic trading became available back in the day. It described the procedure that companies use to optimize the speed at which they process transactions.

Electronic trading enables “straight-through processing” (STP), by which trades entered electronically can likewise be processed (cleared and settled) electronically. Because STP involves no paperwork and little human intervention, errors are mostly eliminated which dramatically lowers operational costs and risk.

In a nutshell, STP enables the entire trade process to be conducted electronically without the need for re-keying or manual intervention.

That’s how STP was originally defined, but then the retail forex industry decided to get creative with its usage.

STP Used as Marketing Tool

Nowadays, it’s used as marketing innovation jargon to imply that the forex broker is not “touching” or interfering with your orders nor benefitting from your losses because it supposedly “routes (or sends) your orders straight through to the market.”

As you’ve already learned, your orders are never routed or sent to the “market” because your forex broker is your sole counterparty and always takes the opposite of your trade.

Let’s see how “STP” execution actually works.

A-Book vs. STP

A trade that is “A-Booked” is sometimes associated with being “STP’ed” or simply “STP”.

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

It’s important to distinguish between the two concepts.

  • STP is known as “pre-trade hedging”.
  • A-Book is known as “post-trade hedging”.

Depending on whether your broker is an “A-Book broker” or an “STP broker”, your experience on how your order is executed will be different.

With an A-book broker, you will experience faster order execution and minimal slippage.

A-Book Order Execution

This is because the broker will execute your trade first, and then hedge. Hence, why it’s known as “post-trade hedging”.

With an STP broker, you will experience slower order execution and a higher probability of slippage.

STP Order Execution

This is because the broker will make sure to “lock in” its matching order with the LP first, and then execute your order. Hence, why it’s known as “pre-trade hedging”.

When your broker executes an offsetting position with a counterparty PRIOR to executing your order, this is known as “straight-through processing” or “STP”.

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

The benefit of straight-through processing for the broker is that it eliminates slippage between its customers’ order fills and hedged trade.

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

In trading lingo, slippage refers to the difference between the requested price and the price at which an order is actually filled.

Slippage typically occurs around times of news or economic announcements and extreme market volatility and can be either positive or negative.

In a rapidly changing market and/or in the event of order transmission delays, the price presented to you may no longer remain in effect at the time your order is executed.

This difference between the two prices is what’s commonly referred to as “slippage.”

If slippage occurs, your broker does not re-quote a price to you. Rather, your order would be executed at the prevailing price at the time the order is received regardless of the direction in which the market has moved.

Slippage is symmetrical. This means that experiencing price slippage is just as likely to be to your advantage or to your disadvantage.

In order to prevent the order execution price from slipping too far from your intended price, most brokers allow you to include “bounds” with your market or entry order.

In that case, your order will not be executed if the price at the time your order is received falls outside of the specified bounds.

For example, if the broker is quoting you a buy (ask) price of EUR/USD at 1.1000, it wants to make sure it’s able to buy EUR/USD at a lower price with an LP, say 1.0999.

STP allows the broker to ensure that it is able to “secure” this price before it confirms its order with you. Otherwise, if it doesn’t, it might LOSE money on the hedge trade!

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

If the price that was confirmed with the LP is different from the one you sent, this is the price that your order will execute, which may be better (“positive slippage”) or worse (“negative slippage”) than what you had expected.

Execution speed is slower because before the broker can confirm your trade, it FIRST must receive confirmation from its LP regarding its trade.

During this process, it’s possible that the price may have moved and the price confirmed between the broker and the LP may have changed. If it has, this is the price that YOUR trade with your broker will be executed.

This is what causes slippage.

When an STP broker accepts a customer’s “order”, the broker is considered to be “working” that order, which indicates a willingness to attempt, but not commit, to enter into the trade at the price requested by the customer.

Here’s a comparison of the different types of order execution:

Types of Trade Execution by Forex Brokers

Riskless Principal

When a trade is executed via STP, this type of transaction is known as a “riskless principal” or “matched principal” transaction.

What is a “principal”?

A “principal” is a party to a transaction. For example, the buyer and seller. It’s basically a fancy word for “counterparty“.

Remember, your forex broker is always taking the opposite of your trade. When you buy, it sells to you. And when you sell, it buys from you.

It is the sole counterparty to all your trades.

This is known as a “principal” transaction.

Counterparty-to-Counteparty Transaction

As you’ve learned earlier, as your counterparty (principal), the forex broker exposes itself to market risk.

But with STP execution, a “riskless principal” transaction is possible.

When you place an order with an STP broker, it immediately attempts to place an identical order (a “back-to-back order”) with an external liquidity provider.

Upon this “back-to-back” order being matched or filled in whole, the broker opens (or closes) the order on your account.

Back-to_back STP Trade Execution

This is how it’s able to act as a “riskless principal” to every trade opened or closed in your account.

A broker acts as a riskless principal because once you submit your order:

  • It first buys from an external liquidity provider for its own account (as principal), then
  • Records that transaction in its own trading book, and then
  • More or less immediately, sells to you (also as principal),
  • Either at the same price (with a “commission”) or at a markup (with no commission).

As a result, there are TWO transactions:

  1. One between you and riskless principal (forex broker)
  2. One between the riskless principal (forex broker) and the “market” (third-party LP).

Matched Principal Transaction

For example, a broker receives a customer’s order to buy 100,000 units of GBP/USD at the prevailing market price of 1.4000 would immediately buy the 100,000 units from a third-party liquidity provider (LP).

Since both trades were executed at the same price (excluding any previously disclosed markup, fees, or commission), this would qualify as a riskless principal transaction.

As you can see, your trade with the broker and the broker’s trade with the LP matches. Hence, the term “matched principal“.

The concept of “riskless principal” and “matched principal” is important to know because it’s the closest thing a forex “broker” can do to act like a true broker.

They can “act” like a broker by being a riskless principal, but unlike a true broker or agent, who simply plays the role of a matchmaker by facilitating a transaction between two separate counterparties, a riskless principal is still your counterparty.

Agency vs. Principal Trades: In an agency trade, you’re acting as an agent for a client and DO NOT take part in the trade. You merely facilitate. This is what true brokers do. In a principal trade, you’re acting as principal and DO take part in the trade. You are the seller to a buyer….and the buyer to a seller. This is what dealers do.

When you enter a market order on your broker’s trading platform, it still takes the opposite side of your trade, but it acts as a riskless principal by simultaneously entering into offsetting trades with both you and an external liquidity provider.

Your broker makes money by adding a markup to the price provided by the liquidity provider and/or charging you a commission. This means that it generates its trading revenues based on the volume of transactions, and not trading profits or losses.

It doesn’t expose itself to market risk, which means it doesn’t profit when you lose. The only money it makes when executing your order is from a previously disclosed price markup or commission.

Brokers who operate this way are designated as “riskless principal” or “matched principal” brokers. 

You can verify if your broker is one by looking at its registration listing on their regulatory agency’s website.