Market Makers vs. Electronic Communications Networks: Which should you choose?

For those just starting out in forex trading, the terms ‘Market Maker’ and ‘ECN’ might seem quite alien – and we certainly don’t blame them. For those unknowing, or for prospective forex traders, knowing whether to use a brokerage firm with an ECN or a Market Maker can be a decision they weren’t even aware they had to make. That’s where we come in. ECN’s and Market Makers both have their advantages and disadvantages, and while ECNs are generally thought of as superior to Market Makers, this isn’t necessarily true. Here, we’re digging deeper into Market Makers and ECN’s to investigate which might be best for you.

What Is A Market Maker?

A market maker, at its essence, is a bank or broker that, at any second of the day, will have a firm ask and bid price. As a result, traders can sell their shares and have their stock purchased without needing to wait for a seller. In other words, market makers are essentially doing what the name suggests – making a market for a particular stock. This can help create faster trades for buyers and sellers alike, but how exactly do they work?

How Does A Market Maker Work?

A market maker will set both the bid and asking prices for a particular stock on their system, which will go on to be displayed publicly on quote screens. From this point, the market makers are prepared at any point during the trading day to complete transactions with their customers and traders. Banks, retail forex traders and more are all found using market makers, proving that this method of trading truly isn’t one to ignore.

Market makers come in two main types:

• Retail – Retail market makers are often smaller than institutional market makers, and are often companies that have been dedicated to offering retail forex trading on an individual scale. Individual traders will usually use a retail market maker, as the services offered are usually tailored this way.
• Institutional – Institutional market makers tend to be banks or other large corporations. Bid/ask quotes are offered to other banks through these market makers, but can spread to institutions, ECN’s or even retail market makers.

Pros

• The Trading Platforms Often Come With News And Charts - Forex trading brokers who utilise market makers often come with a range of charts to use that are accurate to their particular markets and prices. There are also news feeds to keep you up to date with the market, and what you can expect from the trades you are making.
• They Are Usually More User-Friendly - Market makers tend to be far more user friendly than ECNs or any other kind of trading platform. For those new to forex trading, or who may still be getting to grips with foreign exchange and the current rates, a market maker can arguably be a far more newbie and generally user-friendly way of trading.
• Volatility Can Be Lower Than With ECNs - The price movements of currencies are, in general, far less volatile than those in ECN’s.

Cons

• There Could Be A Conflict Of Interest – Market makers are unfortunately known for creating a conflict of interest, as they can often trade against you in order execution.
• Their Bid/Ask Prices Can Be Poor – You may find that a market maker’s bid/ask prices are much higher or poorer than anywhere else at any one time. ECN’s can often offer better rates.
• They Can Meddle With Trades – Most market makers have the chance to manipulate currency prices as and when they like, which can run their customer’s ‘stops’. They can even manipulate rates to prevent customers from reaching profit objectives. Currency quotes can even be moved 10-15 pips away from other market rates.

What Is An ECN?

An ECN, or Electronic Communications Network, is a forex trading protocol. This protocol often serves as a central electronic system that allows traders to exchange through a centralised clearing platform. By connecting traders, brokers, banks and many other market entities, ECN’s essentially create a global liquidity pool. Financial instruments can then be traded, from the likes of stocks to currencies, without any need for a central exchange. There are plenty of brokers on the market that utilise ECNs, and rightly so. But how do they work, and should you opt for this method of Forex trading?

How Do ECNs Work?

ECNs work by collecting prices offered by multiple participants in the market, and will then display the best bid/ask quotes on their trading platforms according to these prices. Unlike market makers who make their profits through the prices they set, ECNs make their profit by charging customers a fixed commission for every transaction that they make. While ECNs – or the authentic ones at least – do not play any role in setting prices, the risks of potential price manipulation are significantly lowered too, making ECN’s a potentially safer way to trade the various commodities available on Forex exchanges.

There are two types of ECNs:

• Retail – Retail ECNs tend to offer quotes from a few banks or other traders on the ECN, but not on a large scale. Retail ECNs are far more individual and newcomer-friendly.
• Institutional – Institutional ECNs often have the best bid/ask prices, as these will come from a wide range of sources including: market makers, banks, hedge funds, large corporations and other relevant institutions.

Pros

• You Can Get Better Bid/Ask Prices – The prices set by ECNs are put together from a wide range of sources, and only the best quotes are displayed in the end.
• Trade On Prices That Have Little Or No Spread Is Still Possible.
• Genuine ECN Brokers Won’t Trade Against You - Your trade orders aren’t often bought by the ECN, so they won’t trade against you. Instead, your orders are passed onto a bank or another customer or institution on the opposite side of your transaction.
• You Can Take The Role As Market Maker – You can offer a price between the bid and asking prices, so you essentially have control over your own little market.
• Prices May Be More Volatile – This is better for ‘scalping’ purposes, but can also be a disadvantage for those with limited experience in entering and exiting trades.

Cons

• Charts and News Feeds Aren’t Always Available – This can make predicting markets and when to enter and exit a struggle. Some brokers will offer these regardless, but it’s not often offered as standard.
• Trading Platforms Can Be Complicated – The platforms that ECNs are usually found on aren’t often user-friendly. In fact, they can be complicated and difficult to navigate if you have limited experience.
• Stop-loss and Breakeven Points May Be Difficult To Predict – The spreads between the bid and ask prices are often varied, and this can make it difficult to predict or calculate the stop-loss and breakeven points in pips in advance.
• Commissions – As mentioned before, ECNs make their money through charging commissions. Whether the extra security available through an ECN is worth the commission is a personal choice to make for yourself.

In Conclusion…

Whether you choose an ECN or a Market Maker is entirely your decision, and can ultimately depend on the kind of trading that you want to take part in. Ultimately, it comes down to the broker that you choose, and what they can offer you regardless of the kind of protocol they choose to use. A broker who takes too long with transactions, or who may not appear user-friendly to your current level of understanding in Forex trading is ultimately one that you’ll want to avoid. Do your research and calculate what it is that you want from your trades, but ultimately make sure that you compare!

Whoever and whatever method you choose, we wish you luck in your trades!