Market maker or ECN is the single most critical distinction between FOREX broker-dealers. A market maker, or dealer, is always the counterparty to your trades; an ECN requires an actual counter order for execution. Given the liquidity of the FOREX markets a counter order is only a problem in a very fast or very slow market or if you place an extremely large order. An ECN cannot play many of the games that market makers do—in large part they do not need to because they have no book to balance. But ECN trading also requires a more accurate and delicate trading touch—an additional skill that the trader must acquire.
Regarding market makers: Some are good, even very good; many are awful. Keep in mind what “counterparty to your trade” means. Then remember that market makers hold all the cards—the data stream, the dealing desk, or control via their liquidity providers with an NDD (No Dealing Desk), the trading platform, and all the tools—requoting, pip spreads, trading rules, dealer intervention, accepting or canceling trades—all for the supposed purpose of maintaining an orderly market. National Futures Association (NFA) Compliance Rule 2-43 has minimized some of these factors—but not eliminated them by any means. Progress is being made but continued excesses will make them the dinosaurs of the industry.
ECNs have their own issues—the biggest one is that their platforms are more difficult to learn and use effectively. They are often bare bones and require integration of third-party charting and technical services. But they have much less leeway because they are functionally trade matchers. In fast or slow markets liquidity may actually be worse with an ECN because they do not have many of the orderly market tools at their disposal. But on balance, I feel that once you have gotten your feet wet in FOREX shop for an ECN. Several retail brokers are offering ECN trading to even mini-accounts. How they bundle 10k lots into a 250k bank lot without intervention I have not fully determined.
The core issue—and the reason the author predicted in the second edition that market makers would lose ground to ECNs—is that market makers manipulate the book to maintain order. This involves a number of activities such as requoting, dealer intervention, and setting pip spread—as and when they please. Market makers trade against their customers—it is why and how they are what they are. A profit for you may well be a loss for them. What would you do with a customer who cost you money on a consistent basis?
Market makers set, manipulate, or control pip spreads usually as legitimate operations of the market-making process; ECNs generally do not. Many trading platforms—both market maker and ECS—provide depth of market (DOM): the ability to see standing buy and sell orders, the quantities and prices bid and asked. This can be valuable information if you learn how to use it properly.
To complicate matters some firms that are obviously market makers now advertise a no dealing desk. The author is unsure how such a hybrid operates; in some instances it appears to be nothing more than semantics in an effort to shake the market-maker moniker. Lack of regulation makes knowing how a broker-dealer processes trades difficult if not impossible. The author queried five such brokers about this process and received no response from four of them and what can only be described as “mumbo-jumbo” from the other one. More and more brokers are attempting to distance themselves from the market-maker label, but whether they are actually making any significant changes to how they execute trades remains a question in many instances. You will hear the term liquidity provider from both ECNs and market makers. For a market maker it really has little meaning but it sounds good. It does not matter how many liquidity providers a broker-dealer has if it stops the feed to sniff and/or manipulate it before passing it through to the customer.
In reviewing the fine print of account forms you notice that even ECNs withhold the right to intervene as market makers. Yes, it is confusing! In FOREX, ultimately, “You pay your money and you take your pick.”
Regarding market makers: Some are good, even very good; many are awful. Keep in mind what “counterparty to your trade” means. Then remember that market makers hold all the cards—the data stream, the dealing desk, or control via their liquidity providers with an NDD (No Dealing Desk), the trading platform, and all the tools—requoting, pip spreads, trading rules, dealer intervention, accepting or canceling trades—all for the supposed purpose of maintaining an orderly market. National Futures Association (NFA) Compliance Rule 2-43 has minimized some of these factors—but not eliminated them by any means. Progress is being made but continued excesses will make them the dinosaurs of the industry.
ECNs have their own issues—the biggest one is that their platforms are more difficult to learn and use effectively. They are often bare bones and require integration of third-party charting and technical services. But they have much less leeway because they are functionally trade matchers. In fast or slow markets liquidity may actually be worse with an ECN because they do not have many of the orderly market tools at their disposal. But on balance, I feel that once you have gotten your feet wet in FOREX shop for an ECN. Several retail brokers are offering ECN trading to even mini-accounts. How they bundle 10k lots into a 250k bank lot without intervention I have not fully determined.
The core issue—and the reason the author predicted in the second edition that market makers would lose ground to ECNs—is that market makers manipulate the book to maintain order. This involves a number of activities such as requoting, dealer intervention, and setting pip spread—as and when they please. Market makers trade against their customers—it is why and how they are what they are. A profit for you may well be a loss for them. What would you do with a customer who cost you money on a consistent basis?
Market makers set, manipulate, or control pip spreads usually as legitimate operations of the market-making process; ECNs generally do not. Many trading platforms—both market maker and ECS—provide depth of market (DOM): the ability to see standing buy and sell orders, the quantities and prices bid and asked. This can be valuable information if you learn how to use it properly.
To complicate matters some firms that are obviously market makers now advertise a no dealing desk. The author is unsure how such a hybrid operates; in some instances it appears to be nothing more than semantics in an effort to shake the market-maker moniker. Lack of regulation makes knowing how a broker-dealer processes trades difficult if not impossible. The author queried five such brokers about this process and received no response from four of them and what can only be described as “mumbo-jumbo” from the other one. More and more brokers are attempting to distance themselves from the market-maker label, but whether they are actually making any significant changes to how they execute trades remains a question in many instances. You will hear the term liquidity provider from both ECNs and market makers. For a market maker it really has little meaning but it sounds good. It does not matter how many liquidity providers a broker-dealer has if it stops the feed to sniff and/or manipulate it before passing it through to the customer.
In reviewing the fine print of account forms you notice that even ECNs withhold the right to intervene as market makers. Yes, it is confusing! In FOREX, ultimately, “You pay your money and you take your pick.”
