The MM model is one of the three main trading models in the foreign exchange market, together with ECN and STP. Choosing a proper broker model is crucial for both investors and brokers in forex trading. This article will focus on the MM model, elaborating its definition, advantages of higher capital adequacy and full license, as well as disadvantages of internal counterparty trading. Protecting investors through understanding broker models is key.
MM brokers take the counterparty of customer trades
The MM model, also known as the Market Maker model, means the broker will take the counterparty position of customer trades internally. Rather than passing orders directly to the interbank market like STP brokers, MM brokers absorb all trading volume into their own accounts. They make profits from the spread between bid and ask prices. As counterparty, MM brokers take risks. If customers profit, the broker may take losses to pay them. MM brokers rely on the 80/20 rule that most traders lose to earn stable income.
MM brokers need to hold larger regulatory capital
To offset trading risks, MM brokers are required by regulators like FCA to hold more capital reserves compared to STP brokers. For example, FCA categorizes broker licenses based on capital requirements into 50k, 125k, and 730k GBP. MM brokers need to apply for the 730k license while simple STP brokers may only require the 125k license. The 730k threshold ensures MM brokers have adequate financial resources to cover potential negative account balances.
MM brokers can offer guaranteed stop loss
With their own liquidity pool, MM brokers can provide traders useful risk tools like guaranteed stop loss. This means traders can rest assured their stop loss orders will be executed at the pre-set price level even during extreme volatility. STP brokers relying purely on external liquidity cannot guarantee stop losses. This advantage of MM brokers reduces uncertainty for traders using risk management.
MM brokers have greater flexibility in operations
MM brokers have more control over their trading environment compared to STP and ECN counterparts. For example, they can customize spreads, execution speed, requotes etc. based on internal policies. MM brokers can also optimize offerings for specific client groups, such as lower spreads for high volume accounts. However, this flexibility means traders need to do due diligence on the broker’s practices.
MM brokers face conflict of interest risks
The most common criticism against MM brokers is the inherent conflict of interest. As counterparty to customer trades, a shady MM broker can manipulate pricing and execution to take the opposite side of winning trades. While regulated MM brokers have standards against abusive practices, traders should still be aware of the risks.
The MM model has pros like higher capital adequacy and flexibility as well as cons like conflict of interest. Investors need to understand broker models and make informed choices. Regulated MM brokers can provide useful guarantees but traders should still exercise caution. Ultimately, researching the broker thoroughly and managing risks properly is key for forex investment success.