Market Makers And Electronic Communications Network – A Comparison

The Forex market is one of the most exciting, liquid, and fast-paced financial markets in the world. It also operates 24 hours for 5 days a week and is globally dispersed with no central exchange such as the New York Stock Exchange. Unlike trading in stocks, Forex trading transactions are OTC in nature and largely electronic, allowing brokers and traders to make a deal directly with each other.

One similarity that Forex has with the equity market is that anyone interested to trade in them need to open a trading account. Retail traders and investors gain entry into Forex primarily through two types of brokers, namely, market makers or STP companies and electronic communications networks or ECNs. Both kinds have their own pros and cons, and these are described in the succeeding paragraphs. Market makers

There are two main kinds of market makers, namely, retail and institutional. Retail market makers are companies that offer retail Forex trading to individual traders. Institutional market makers are banks and large financial institutions that cater to bigger market players.

A market maker is a company, or an individual, that quotes both a buy and a sell price in a financial instrument or commodity held in inventory. The difference between the price at which a market maker is willing to buy a currency and the price at which he is willing to sell it is called a spread. A market maker’s spread represents his profit on each transaction.

The main advantage of opening an account with a market maker is that currency price movements aren’t as volatile in comparison to ECNs. On the downside, they tend to have bid/offer quotes that are not as good as those offered by ECN brokers. The quote displayed by market makers may also “freeze” during times of high market volatility, such as during the release of economic reports, to remain profitable. Electronic Communications Network or ECN brokers

ECNs derive prices from multiple market participants from banks to individual traders in order to display the best bid and ask prices on their platforms.\ ECNs obtain prices from several sources which include big financial and banking establishments and retail traders and the best ones shown on their respective platforms. In such regard, the ask/bid prices displayed by ECNs are usually more favorable than those given by market makers. Also, ECN brokers do not profit from the spread, rather, they earn it from a fixed commission which has been pre-determined prior to the trade. The main disadvantages of ECNs is that it has higher variability in ask/bid prices which makes calculating for stop-loss limits difficult sometimes and that you have to pay commissions per trade.

Forex is exciting and fast paced. In order to start trading in Forex, you need to open an account with a broker. Find out about the two major types of currency market brokers and their respective advantages and disadvantages here.

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