ECN vs. Market MakerEcn Vs. Market Maker
An Electronic Communication Network (ECN) broker is a financial intermediary in the Forex market that connects directly to liquidity providers, which takes a customer’s order, often smaller market participants and tries to match it in the market with an opposite order and executing it if possible. This way, customers are investing directly in real suppliers' market quotes. A true ECN broker matches trades between market participants; hence trading against customers is not possible. Examples of ECN brokers are Instinet, and EDGX etc.
The Market Maker, on the other hand, has the ability but no obligation to buy the shares offered by its customers and to execute them.The same broker could also be responsible for placing trade operations opposite to that of its customers. Such brokers will perform this type of transaction by buying them if it thinks it can sell them, perhaps a few seconds later at a higher price.Otherwise it can pass the order to another MM that usually "as a favor" will realize a commission or send it to another ECN broker.
Once the ECNs were only for institutional traders, while private traders could only operate through Market Makers and the two types of brokers were opposite to one another. Today, with the rise in the popularity of forex and the increase in competition, these barriers are falling, so ECNs are becoming increasingly available within the reach of small traders. It is important to add that not all ECNs are designed to serve retail traders; some are actually designed exclusively for institutional traders. However, many differences between these two types of brokers ECN and Market maker still remain.
Differences, Advantages and Disadvantages
- Fixed commissions
ECN brokers always have fixed commissions applied to the opening of the single transaction, which are its main earnings.
The Market Maker broker often does not have fixed commissions, and those with commissions are usually few in number, and small in financial capacity.
- Initial deposit
ECN brokers tend to offerhigher deposits than the market maker, although lately the ECN has lowered these limits to attract more customers.
The Market Maker Broker allows for sufficiently small deposits to attract especially beginner traders who also want to invest only $100.
ECN brokers provide the most professional platforms, although at first glance may seem more complicated, offering advanced features that are not usually found in retail platforms. Lately some have been offering common use platforms (such as metatrader platforms) to approach retailers.
Market Maker brokers usually provide easy-to-use and intuitive platforms that have similar features to other market maker brokers. Most brokers provide Metatrader, a complete and flexible platform that has become the standard platform for retail traders.
- Financial Leverage
The ECN broker has lower leverage than the marketmaker and that's why a substantial capital is necessary. Lastly, the ECN trend is to increase this leverage to better adapt to marketmakers’ policies. The Market Maker broker has very high leverages, also allowing for trading with minimal capital, but thus having greater risk of losses.
- Stop Loss
The ECN broker can’t guarantee a stop loss as it’s simply an order, so if there is no counterpart in the market willing to pay that price, the order can’t be executed. This is very rare for liquid assets like EUR/USD and more frequent for less liquid assets such as exotic currency pairs.
Some Market Maker brokers offer guaranteed stop losses, this is possible because the broker sets up as a counterpart and the order is executed even if there are no other market orders willing to take the other side of the trade.
- Negative Balance
Some ECN brokers do not have a system where they automatically close the transactions that are leading to a negative balance account, and may ask you to pay an additional sum to cover it in this case. Some ECN Brokers have already implemented systems that avoid this problem; however it is always good to keep track of trades.
The Market Maker broker will automatically close the ongoing transactions if there aren’t enough funds to cover the losses. You will never lose more than you have in the account.
- Fixed Spread
ECN brokers do not have fixed spreads, so you have to be careful before opening up a position especially during financial news or in a period of high volatility.
Market Maker Brokers in many cases use a variant of varying and fixed spread on each currency, allowing the trader to work more smoothly.
- Width of Spreads
ECN brokers have very tight spreads or in some cases nonexistent. Direct access to the market is the same as in the interbank market. It does not act on spread as its earnings come from commissions.
Market Maker broker has higher spreads because most of his earnings comes from it, and can freely change it according to its decisions.
- Execution of orders
ECN brokers manage orders directly on market liquidity and are virtually executed instantly. It might not run the order if there are no counterparts for it.
The Market Maker broker has the discretion to execute the order on the market, acting as a direct counterpart of its trader, using other market makers or other ECNs, and any one of its execution channels could lose several seconds before executing the order.
- Price manipulation
The ECN broker performs the transaction on the market by allocating the best available price, has no influence on the price allocation. In order words ECN trading activity is anonymous which allows traders to real market prices.
Market Maker Brokers, to perform operations, aside from using the liquid market directly, can use other channels such as other MM or other ECNs, or can often become counterparts of their trader. This gives it the freedom to freely manage the prices displayed to its customers. For this reason in some moments in real market and brokerage prices differ significantly. In the past, this freedom was used by the brokers in a dishonest way; in fact, it was not uncommon to find pricing fluctuations in prices to strike customers' stop losses, which nowadays with a lot of regulation occurs only on unregulated brokers.
The ECN broker has no restriction on scalping style trading. Scalping trade system, with its small dimension suits the ECN brokers thanks to the reduced spread. But beware of commissions that may be too high.
Market Maker Broker, in some cases, does not allow this kind of trading, and those who often allow it have spread costs that dramatically affect it.
ECN brokers at times of volatility could experience slippage on orders, but very limited compared to marketmakers.
Market Maker brokers have less privileged access to the market, and often relying on other ECN brokers to run, therefore slippage at high volatility times becomes more frequent. In addition, being able to handle prices freely in the past, slippage was used unkindly for the purpose of operating at favorable prices, which nowadays with much regulation, only on unqualified brokers.
- Direct access to the market
The ECN brokerage orders are transferred to market liquidity without the intervention of a Dealing Desk, therefore offering a high speed of transaction.
The Market Maker broker, as explained above, runs directly to the market in different channels that sometimes can be slow, even take several seconds.
- Market depth / volumes
With the ECN broker you can always see the depth of the market knowing at any time the volumes available and at what prices are offered. In simplistic terms, this is very useful especially for those who work with large volumes like institutional traders because they need to know if there is enough liquidity in the market for their order to be accepted. It is also important to have an idea if there is an imbalance in the market on buying and selling pressure.
Market Maker broker does not often have the chance to see the depth of the market but it is not essential for small traders.
the Analyst's answerJean Grossett - Financial analyst
Both ECN and Market maker brokers have their advantages and disadvantages which tend to favor traders of varied risk appetite. These broker variants are both speculative and involve substantial risk of loss because of their nature as leveraged products. Although there are Market maker brokers who carry out an illicit practice of trading against their clients, there are other regulated ones who do not engage in such unscrupulous activities.
From experience, I tend to have a preference for ECN brokers because of a confidence that my broker will not be able to trade against me or spike my stop loss level. However i will advise that you carry out your own due diligence on different brokers not just from their web sites and chat rooms, but on review websites and forums without conflict of interest where traders have used their services and share their experiences. Also, because a broker is regulated does not take away the need for every ‘would be trader’ to dig deep into reviews and reputation of such brokers. Verifying their registration claims on the various authority websites could go a long way to generally double check on brokers.
Finally, a good regulated broker is not a substitute for carrying out best practices in the form of personal analysis of different markets of interests, and money/risk management.