ECN vs. Market Maker Comparison
This article assumes some knowledge of the way the forex market and
forex brokers work. If you are not familiar with this, we recommend that
you first read our "Structure of the Forex Market" and "How Forex
Brokers Work" articles. Contrary to popular belief, ECN's are not
superior to Market Makers in every way. There are advantages and
disadvantages on both sides.
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There are retail market makers out there today that allow traders to
begin with $1 in their accounts. That’s not to say that this is a great
feature, but it does present options to people who may not have the kind
of money it takes to open a Currenex account. It’s a good thing too,
because ECN contract sizes are often multiples of $1 million, and some
ECNs expect a daily volume of $25 million. Shackled with those types of
minimums, you had better be well Capitalized (with a capital “C”).
ECNs don’t allow the type of high leverage that is typical of market
makers. To most people this is no great loss, since it is generally not
advisable to use anywhere near the leverage that is available at most
retail market makers.
Transaction Costs
Whether they call it a spread or a commission is really irrelevant at
the end of the day - no matter what, you have to pay to play. ECNs
typically give you the prices they are dealt from their liquidity
providers, with the exact same spreads, but then charge a commission for
every round turn trade. This allows them to give discounts to high
volume traders, lowering their costs, but to most traders, it is really
irrelevant whether they are made to pay a commission with a tight spread
or no commission with a higher spread. It works out to be roughly the
same, depending on which brokers you are comparing, and what current
spreads are like.
The potential volatility is higher on ECNs because of their
unfiltered slice of the market. By risking some exposure, market makers
can generally mitigate this. Depending on the type of trader you are,
volatility may be your friend or your enemy.
- Stability of Business Model
The fact that a market maker is the counterparty to many of its
clients’ trades, exposes it to market risk. While this risk should be
well managed through appropriate hedging with a higher-tier
counterparty, this may or may not be the actual case. Furthermore, even
if the risk is well managed, it is still a risk. An ECN does not have to
worry about this, as it provides only a service for which it charges a
commission. At no point is an ECN exposed to market risk. What this
means is that the likelihood of an ECN becoming insolvent is much lower
than that of a market maker. This has serious implications for client
funds which the broker is holding. On the other hand, any market maker
worth its salt should keep client funds segregated from the company’s
operating capital, itself be well capitalized, and keep risk management
tight, therefore keeping clients relatively insulated against the
possibility of broker bankruptcy.
- Susceptibility to manipulation
While ECNs offer a “truer” participation in the market, the picture
there is not necessarily prettier. The added transparency only brings to
light the dog-eat-dog world that is the forex market. Trading with a
market maker insulates your from that to some degree, but this can also
be used to hide things from you. It is nice to have guaranteed stops,
though, and you won’t find those on any ECN. Basically, in my view, ECNs
are great for experienced day traders and scalpers, while market makers
are better for everyone else, as long as they are deemed to be
"honest".
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