Trading with ECN versus Market Maker

Trading with ECN versus Market Maker

If you are about to undertake the selection of a broker for Forex trading, then you will need to decide whether you want a Market Maker or ECN.  Many of the firms out there are Market Makers and it was previously difficult to find ECNs, but that has changed with an increasing number of ECNs becoming available.

So what does Market Maker mean?  And what is an ECN?  A market maker "makes" prices available to you, the buyer.  If you have ever gone to a foreign currency exchange booth at an airport or in a tourist area, you were essentially working with a market maker.  The market maker offers you a buy price and a sell price, thus "making the market".  There is a spread between the two prices meaning that the market maker will buy a currency for less than they will sell it.  That spread is how market makers profit; they just buy low and sell high.  ECNs are Electronic Communication Networks.  They are basically networks of buyers and sellers who can intercommunicate.  Instead of going to one broker who is buying and selling to everyone and operating as an intermediary, ECNs are connecting buyers and sellers together and just charge a commission for trades.  They don’t worry about the spread because they aren’t actually holding currencies, but rather just connecting people who are interested in buying and selling.

There are advantages and disadvantages to both systems.  Market makers will generally offer an easy to use integrated system for trading with a lot of charting and analysis software and that is nice to have.  But there are problems.  What happens if something devastating happens to a country and will negatively affect its currency.  The market makers then aren’t going to be in a good position to buy, buy and buy that nation’s currency since traders are anticipating a decrease in prices.  So problems result.  Suddenly the market maker’s best interests are directly in conflict with the investors.  Software glitches might occur or perhaps trading becomes unavailable.  Sometimes the spreads suddenly grow larger. Frustrated traders accuse the market maker of causing losses and sometimes even lawsuit have been launched.

These problems with market makers led to the development of the ECNs where traders can interconnect directly with each other and don’t have to worry about depending on one broker.  Traders don’t have to worry about big spreads but things are now more chaotic.  If you place a market order in an ECN it can change so quickly that by the time your order has reached the ECNs computers the prices might have radically swung.  Things happen much faster in a truly open market.  Additionally, because the ECN isn’t operating in a closed environment the tools are more limited than what were available under the market maker’s system.  Traders might enjoy the small spreads but then have problems because prices move so quickly that orders don’t occur at the prices that were intended.  Each ECN will have a different size and different players and usually the ECN won’t reveal who they deal with, so it is up to the trader to investigate and decide which ECN is best.

It appears that many serious Forex traders are moving toward the ECN model of trading because dealing with many buyers and seller can be more profitable than working with just one.  However, that doesn’t mean that Market Makers have lost their importance.  If a trader is planning on trading on fundamental analysis then a spread might not be so important since the outlook is over a long term.  The stable prices can be good for traders under some scenarios.

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