What is the difference between ECN and Market Maker?

Chris Lee

For all traders, one of the most important things to consider is exactly what type of broker you are dealing with.  All brokers are not the same and it is worth considering the 2 main (and completely different) business models that brokers use – ECN Vs Market Maker.

ECN

If you trade with an ECN broker, your trades flow directly to the best price offered by a liquidity provider without price manipulation from the broker. ECN forex brokers aggregate a list of all the best bid and ask prices from liquidity providers or the interbank market (usually major banks and financial institutions) and match trades with the best possible prices and lowest possible spreads without considering the source.  The leading true ECN brokers use the best technology trade servers such as NY4 & LD5 data centers in London & New York which are connected via fibre optics to their ECN network and liquidity providers, ensuring lightning fast execution. The advanced price aggregation means increased pricing transparency, lower or narrower price spreads, no slippage and the fastest possible trade execution.  Trades feed straight through to the best price available without interference from a “market maker”.

Unlike fixed spreads, which are offered by some market makers (see below), spreads of currency pairs vary on ECNs, depending on the pair’s trading activities and during period of high trading activity, some brokers will offer no ECN spread at all/zero spreads especially in the more liquid currency pairs such as the majors and some currency crosses.

The broker makes money on the spread, meaning that they want active, profitable traders that will be long-term traders. An ECN forex broker can be seen as a middle-man between buyers and sellers with no interest in interfering with or manipulating prices.  Electronic networks also make money by charging customers a fixed commission on each transaction but authentic ECN brokers do not involve themselves in making or setting prices which in turn reduces the risks of price manipulation for retail traders.

Market Maker

The other type of broker is a market maker.  Unlike the ECN broker, who feeds orders directly through to a liquidity provider offering the best price, a market maker may be more incentivized not to offer you the best price available due to the conflict of interest.

Market makers basically “make” the Forex market on top of the real market and your orders rarely actually reach the real market. If you are trading currency pairs with a market maker, you do not get direct access to the underlying liquidity which makes up the Forex market. They are also referred to as dealing desks as they are an artificial type of broker as the market is not reflected directly, only prices being quoted.

As counterparties to each forex transaction in terms of pricing, market makers must take the opposite side of your trade. In other words, whenever you sell, they must buy from you, and vice versa and hence they want you to lose! In the worst case scenarios, price manipulation and stop hunting can also occur under this model.

The exchange rates that market makers set are based on their own best interests and the way they generate profits through their market-making activities is via the spread that is charged to their customers. The spread is the difference between the bid and the ask price, and is often fixed by each market maker but are normally kept at a reasonable level as a result of the intense competition between numerous market makers.

Traders should carefully consider their choice of broker as the type of broker that you pick can significantly impact your trading performance.  Trust, reputation, regulation and business model (i.e ECN or market maker) are important factors in a client’s decision-making process when choosing a broker and it is important to do your research properly.

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Chris Lee

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