Topic: Market Maker and ECN: The Differences
- 5 February 2016 at 11:03 #2812adamsmithsParticipant
There exist mainly two types of brokers in the FX trading space. These are: Market makers and Electronic Communication Brokers. The former functions in the manner of setting the ‘bid’ and the ‘ask’ prices on their platforms, and afterwards it displays them on the Quote space. These are the prices they set, and at which they trade with their clients. Now, these exchange rates are fixed in a way that caters to their (market makers’) interests alone. Though, most of them are forced to keep the rates reasonable in order to stay in competition, they nevertheless try to keep the spreads (the difference between take and stop prices) profitable. As the counter-parties to your forex transactions, a lot of them try to hedge or cover your order by passing it on to someone else, or they might even trade against you. There are two kinds of people in this business of market-making: Retail and Institutional. In this kind of brokerage system, you run the risk of suffering losses, since the market makers’ profit lies in making you lose, and there’s a chance that you could end up with higher bid and ask prices that what you could get from an ECN. Market makers are able to manipulate the prices of currency pairs to run price stops on behalf of the client, or they hinder the clients’ trade from closing on a profitable target. The market makers will only let out negative slippage and not the positive ones, and their Quote screens tend to become dysfunctional in times of high volatility.
What they do is to connect you electronically to the liquidity supplier market like Banks and Financial institutions so that you can do business with them. ECNs flash the prices from a variety of sources, and they display the most viable bid or ask quotes on their platform screens. Like market makers, ECN brokers also act as counterparties to forex transactions, however, the latter does not trade against you. They connect you to the real market and display you the real trading activities and hence you see the constantly fluctuating prices of a certain currency pair. Their service and role end with connecting you. And in return, they charge a definite percentage of commission. Since ‘authentic’ ECNs do not play any role in the setting of the prices, the risks of price manipulation are non-existent.
Just like market makers, there are two main types of ECNs: retail and institutional. Since your prices are sourced from a huge variety of providers, you can get better bid and ask prices and can transact choosing the prices with minimal spread. The broker does not trade against you, and therefore they cannot run stop loss orders on your behalf. ECN brokers allow you to have a glimpse of both positive and negative slippage, therefore you can benefit from them.
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