ECN vs. the Market Makers: Who’s the King of the Hill? |
Like our children often argued on whether Terminator beat Robocop or vice versa, one of the most discussable topics through FX trading world is, which is better, the ECN brokers or the market makers. Well, answering that will be possible if you know your ultimate goal. Once you got it, then we need to explore what actually differs from the ECNs and M-Makers. Furthermore, read 5 Forex broker types you need to know about.
The Market Makers' Quandary
It’s a well-known fact that retail brokers are the party to all Forex transactions.
I got an example for you. Imagine two FX participants, where Bob is selling while Jessie is buying; at this time, an exchange broker gets his cut presenting Bob and Jessie and holding the transaction. At TopFX, for instance, whether Bob is buying or Bob is selling. TopFX is the counterparty to his trade. TopFX has a couple of tricks to apply; they can put that trade into the pool and afterwards cover their position with help of their liquidity provider who is equal to their own position, or they can just hold on to Bob’s position, considering that he is likely to lose a position anyway. No matter which action they take, there’s only a single movement (or at most two), in the ECN type of environment, between Bob and the other party.
The difference in steps is where Bob’s market maker’s problems lie during high volatility. Let’s say there is a central bank somewhere which issues the “powerful” press release to greatly move the market. Bob and his broker had a deal where the last one promised some serious stuff. Not a forever love or “fills guaranteed”, or “fixed spreads” etc. but then comes the CHANGE. So TopFX’s clients are up to the news trading – their strategy works as market conditions are predictable. However, news releases make TopFX nervous as their business model is insufficient enough and brings losses. The reason why they are losing lies in those couples of steps between Bob and the bigger market.
You see, TopFX is selling the relative currency to Bob and other thousands of their clients at the time when no one else does it. Therefore, no one is willing to sell to Bob, and no one is going to sell to TopFX as well, so TopFX is unable to cover their trades. The only solution they have is to play against the client: widen the spread, or “create” some slippage, or simply close down before any news reports are released.
The ECN Way
A human nature has remained the same for ages – our expectations are based on what we think we know. Don’t believe the FX ads which tell you about low-and-lower spread as 1 pip or absolute inter-bank access whatever. If you take all of these tales seriously the “real” market will hit you hard.
Just to say, we expected ECNs brokers to be a lot like “old-fashion” ones, but with no being ripped off by their dealing desk, and having the benefit of tighter spreads. Be realistic. Still, you will be experiencing a sort of slippage when trading your ECN account. So, you get what you wanted to.
Huge exclamation mark! ECN environment is no grocery shopping in a super-market where every can of beans has it sticker price. FX traders have been swayed by the simplicity of retail brokers, and they don’t actually care for how the market really works to increase their own profit margins.
In the real FX market like the Inter-bank network, a market order is a market order. Traders ask for a currency at a market price is simple enough to understand. What’s complicated to comprehend is the swiftness in the market movements? In the very second between your brain’s strike to buy/sell a currency at a specific price, and the pressing of your finger on the keyboard to put that market order in, the price changed. Your market order for a USD at 0.9626 hits the “real” market, when a seller of that USD is sitting at 0.9826 or even higher.
The ECN-style market reality is that sometimes there just may not be anyone buying at the current price you’re selling, and vice versa. This may be difficult to accept for some traders, who will think they are cheated when they thought better the ECN guys would be better.
It’s doubtless that after only a couple of days on your ECN-style platform. You'll get your first understanding of how things work after any of economic reports has been released. You’ll be gladdened to see that you’re not receiving those weird fixed spreads – pips of 20, 30 and even up to 50 – like you’d get from your old TopFX platform. However, what will eventually throw you for a loop is the frenzied spreads you will see – widening, narrowing, even inverting at some point? Scary stuff; especially in the few seconds before a press release comes out. You can bet that banks are pulling their orders, and last second speculators are standing at the ready. It’s a dangerous world. At the same time, it’s closest to how the inter-bank network really works. A kind of like an aerialist working without a net beyond. You won’t find any guaranteed stop losses on the ECN platform. You’ll only find real buyers and sellers and transactions of whatever the market can and will bear.
What about commissions? Well, your ECN broker works for a profit, doesn’t he/she/them? So, they will charge you a commission or fee for every transaction. That’s pretty obvious, unlike TopFX, who hides the broker profits between the price of the liquidity provider and your price. And while commissions and fees will differ among them, generally most of the ECN brokers charge 1 or 2 pips for each round turn, of course dependent on the currency paired. Your ECN broker has to show a spread of a pip or two (or less) as compared to the old market maker broker you used to use. However, are the net spreads from your new ECN broker better than TopFX’s? The answer is Yes and No.
So, who is the King of the Hill? ECN or Market Makers?
Hopefully, you know now how each type of broker is structured, and what are their specific advantages and disadvantages. Active FX traders may likely be more pleased with an ECN styled broker; a novice trader might better take the simplicity of a well-experienced market maker broker that has the requisite safety features.
Who is better? It’s really a matter of personal choice and needs.
Article was written by Alexander Collins, who is a creator of Forex robots and blogger. Also find out Forex trading tools for better Forex trading on Alexander’s blog.
About the author: forexmansion.com
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