I did not understand during a long time the difference between the various types of brokers existing on the foreign exchange market. The broker term is often used besides with twists because it is not all the time the case. In fact they should be differentiated according to their business model. Currently, there exist three great types of actors on the eForex from which the two last are most accessible to the private individuals:
* - ECN
* - Pure brokers
* - The market makers
ECN
The ECN (electronic communication network) are market places. All the operations are carried out directly on the interbank market. It is what one calls “No dealing desk”. Thus, as well as on Euronext for the market action, the book-building is posted. The participants are thus counterpart vis-a-vis the other participants because as you it can to buy, a salesman is needed opposite. The ECN make matcher the orders of their various customers. Do you put yourselves surely the same question that I am posed with the departure, how made one when there is nobody opposite? It is very simple, they appeal has suppliers of liquidities (liquidity provider or LP). These suppliers of liquidities are banks which make it possible to the customers to have an important liquidity and to obtain tight spreads in normal market condition. The prices are posted in real time and thus reflect the prices dimensioned by the various banks. That allows a total transparency of the market by giving access to information to the whole of the participants. Each liquidity provider (supplier of liquidity) posts its prices permanently and can type in the posted liquidity. The disadvantage is that the spreads are not fixed, in particular when volatility increases at the time of important economic advertisements. Sometimes the spread can reach 15 pips on the EUR/USD.
The ECN were reserved a long time for institutional but certain brokers propose this service with the private individuals today. In this last case, the ECN play them same the role of supplier of liquidity. The liquidity is some thus reduced compared to a supplier such as a bank.
The main advantage of the type of operation is that you keep anonymity and that the ECN cannot know of which account comes the giving orders. One cannot thus treat against you, I would reconsider this point later. This is a great advantage in particular for the scalpeurs. You can also decide to place an order between the bid price and the asking price.
The ECN are remunerated by commission on the volume treated by the traders. Often, that is around 10 has 20$ per treated million.
Pure brokers
The pure brokers have about same operation as the ECN with the difference that the liquidity suggested to their customers is ensured in all the cases by a supplier of liquidities. This supplier is a bank what thus ensures an important liquidity. The pure brokers are thus of mere intermediary between its customers and the bank. The prices are thus those posted by the bank on the interbank market finally not in all the cases. Indeed, the pure broker can be remunerated in two manners. The first, it is by the volume of transaction carried out by its customers (4 has 5$ per treated million for example). It is often that which is privileged and which makes it possible the broker to reduce its spreads. Second is what one calls the markup (ex: addition of a pips to the best offer and withdrawal of a pip to the best bid of its liquidity providers). The pure broker then gains a pip on each transaction.
The pure brokers do not take positions against you since they are autohedger by their liquidity provider. Even if contrary to the ECN, your anonymity is not kept, the scalping is thus authorized because the broker is not risks some even if you keep your position a few seconds.
In addition to a more important liquidity, the pure brokers propose advantages compared to the ECN in particular in the client relationship and the services brought. You will frequently have a range of tools higher, of the councils, analyzes, signals, subscription has systems of trading, managed accounts.
Market Makers
The market makers finally, are anything else only a little particular brokers. They generally post fixed spreads but the principal difference with the pure brokers is it not transparency of the prices. The market maker can decide to dimension apart from the prices of its suppliers of liquidities (LP) constantly, it is in particular the case at the time of the advertisements, certain brokers solidify their prices literally whereas the banks move in same time… but because of the guaranteed fixed spreads this is a normal thing. It should be known that when your Broker proposes 3 to you pips at the time of Nona farm Payroll, during this time half of its LP dimensions spreads of 10 or 20 pips. The only means for him of adjusting its risk while preserving a fixed spread is to solidify its price or contrary to brutally shifting it towards the other side of the fork.
Market Makers are probably the types of intermediaries which developed these last years. The spread fixes and the stops guaranteed there are for much. The latter found a formula which simplifies Forex for the particular customer, even the institutional one which wants to make a little FX without it being its principal activity.
The market maker takes a contrary position with your to be covered. It will be most of the time against you in his book since it is him which ensure the intermediation between you and the supplier of liquidity. The risk management is ensured by the risk book which gives the position in volume on each currency. Actually, below a certain amount (around 50K), the market maker compensate for the orders as interns without the router towards the market. Thus if you are “Too” profitable, you affected their “profitability”… All the markets makers do not practice this kind of operations but that arrives.
With the top of 50K, it is the supplier of liquidity thus the bank which covers the operations in return for a commission, or then the market maker itself.
To be remunerated, it can is to make pay a commission on volume of transactions or then increase by a pip the spread offered by its supplier of liquidity. This spread on the EUR/USD is of 2 pips. If a broker has a spread of 2 pips and no commission takes, it is often that it is remunerated thanks to the trades losers of its customers.
Most market makers do not accept the scalping because they do not have time to be covered. When it accepts it, quotations are the bid prices by the bank and thus the spread becomes variable. That is then made on a separate account scalping.
Conclusion
ECN:
Advantages: transparency of the prices; visible book-building; possibility of placing an order in the price range; scalping authorized; anonymity during the giving orders
Disadvantages: Spreads variables; less important liquidity; important commissions
Pure brokers:
Advantages: Important liquidity; transparency of the prices; many services offered; scalping authorized; The broker is not against you
Disadvantages: Spreads variables; commissions
Market makers:
Advantages: Spreads fixed; No commission; No the slippage
Disadvantages: Prohibited Scalping; quotation erroneous; if broker book only, gain much and you will not be it welcome.
