Market Makers vs ECN Brokers
Many Forex brokers advertise themselves as ECN brokers. ECN is an automated system that matches buy and sell orders for a variety of different investment vehicles. An ECN connects large brokerages and individual traders so that they can trade directly with each other without going through an intermediary. An ECN eliminates the role of the third party in executing orders entered by an exchange market maker or OTC market maker. ECNs allow investors located in different geographies to trade quickly and easily with each other.
What is the difference between an ECN and a market maker? Market makers “set” or set both bid and ask prices on their systems and display them publicly on their quote screens. They are ready to transact at these prices with their customers, be they banks or retail Forex traders. By doing so, market makers provide some liquidity to the market. As counterparties to every Forex trade in terms of price, market makers take the opposite side of your trade. In other words, every time you sell, they have to buy from you, and vice versa.
Market makers are able to artificially manipulate spreads for their own profit. They make money on the actual spread between the buy price and the sell price. ECN brokers, on the other hand, typically charge a commission for each trade but make no money on the bid-ask spread, which puts them in a position of not having to manipulate spreads.
ECNs display the best available offer and request quotes from multiple market participants, then match and automatically execute the orders. ECN brokers facilitate trading on major exchanges during market hours as well as trading after hours. ECNs enable automated trading, passive order matching and fast execution. Orders placed through ECNs are usually limit orders.
ECNs transmit prices from multiple market participants, such as banks and market makers, as well as other traders connected to the ECN, and present the best bid/ask quotes based on these prices. Similar to market makers, ECN brokers also serve as counterparties to Forex transactions, but they operate on a settlement rather than pricing basis. Unlike fixed spreads, which are offered by some market makers, currency pair spreads vary on ECNs depending on trading activity in the pair.
Just like with market makers, there are also two main types of ECNs: retail and institutional. Institutional ECNs bring the best bid/ask from many institutional market makers such as banks to other banks and institutions such as hedge funds or large corporations. Retail ECN,
on the other hand, offering quotes from only a few banks and traders on the ECN to the retail trader.
Your trading performance can be significantly affected by the type of broker you choose to place your trades with. If a broker does not execute your trades in a timely manner and at the price you want, a good potential trading opportunity may be lost. Before choosing a broker, it is therefore very important to carefully weigh the pros and cons of each broker and choose the one that best suits your personality and trading psychology.