How Brokers Make Money
Naturally, Forex trading brokerage is no charity. Like any type of business, it is designed to bring revenue to the owners. Brokers are intermediaries — they connect clients to global markets. Aside from currencies, you may access the stock exchange, precious metals, and derivatives. This requires a live account one can obtain through a broker.As you may guess, an intermediary charges clients for their operations. If you make a profit, so does the company. The way its revenue is structured differs. Two existing models are a market maker and ECN. To see the benefits of the latter, let's first consider the former.
Drawbacks of Market Makers
As the term suggests, these brokers can make the market. They set their own prices — the Ask and Bid values used by traders. The rates clients see slightly deviate from the actual quotes in the foreign exchange as charges are included. As a result, there is no way of knowing exactly how much each operation costs.These brokers are also known as the dealing desk brokers. All requests are held within their systems and executed at their discretion. When you buy a currency, a broker sells it, and vice versa. This means a market maker is also a liquidity provider: when you win, the profit is paid from their accounts.
In theory, this business model makes price manipulation easier. Traders are oblivious to the costs, so the company may tweak the rates as it wishes. The system pits its interests against those of the clientele. This surely sounds menacing.
However, as the industry is highly competitive, companies have to offer favourable conditions to survive. Thus, even market makers provide tight spreads these days. Such companies may also be officially licensed by credible regulators like the FCA in the United Kingdom. It is true for Forextime that is a market maker and ECN at the same time.
Definition of ECN
The abbreviation stands for electronic communication network. Such brands provide transparent pricing, as they charge a commission per trade. The quotes on their platforms reflect the actual market valuation. Thus, you know exactly how much one trade costs. And this is only the first benefit ECN trading provides!1. Additional Liquidity Sources
Secondly, ECNs do not provide liquidity. Their function is to connect you to various liquidity providers in the OTC market. These are banks, brokerages, and other traders. Thus, they merely function as intermediaries receiving a commission regardless of your performance. When you make a profit, it is not deducted from their accounts.As you can see, this arrangement is more conducive to fair play. There is no dealing desk. Your orders go directly into the market, and the connection to the buyer or seller is direct. Buy and sell orders are matched automatically at the best available price.
2. Better Pricing
ECNs have a wider market reach. They connect you to a multitude of liquidity providers, which also results in better quotes. Many traders choose ECNs because of favourable spreads, real-time pricing, and speedy execution.
3. Clear Costs of Trading
With ECNs, your costs are always crystal clear. Commissions are fixed and perfectly transparent. Clients have peace of mind. In comparison with market makers, spreads are more narrow. Whether you win or lose, a broker will still receive their commission.The spreads are also variable. This is because quotes are always changing. These shifts are the strongest when trading sessions overlap. Thus, a genuine ECN will offer floating spreads, not fixed ones.
4. Guaranteed Anonymity of Trading
Many traders seek anonymity, particularly those whose volumes are large. Fortunately, trading through an ECN broker is a way to guarantee this. The prices you see are real live market quotes.5. Automatic Market Execution
All orders are matched and executed automatically at the most attractive price available. Traders receive immediate confirmation. In addition, there are no requotes, as a dealing desk does not exist.Choice of Accounts
Big international brokers like FXTM over both types of accounts. Their clients may choose between paying a commission and accepting wider spreads. The provider is regulated in several jurisdictions, including South Africa. Licenses from the FCA in the United Kingdom, the CySEC in Cyprus and the FSCA attest to its credibility.
How ECN Trading Works: Example
Trading commences when a liquidity provider (e.g., a bank or another trader) enters an order into the ECN system. It is subsequently received by the broker. The company collects current quotes and displays the most attractive ones, so traders act on them. All ECN trades are matched between the users, and the order is eventually received by the liquidity generator.One may think of an ECN system as a hub in which big players act as liquidity sources. The company uses the network to provide clients with direct access. Considering the colossal size of the real currency exchange, it is clear why ECNs are so attractive to many savvy traders.
Is There a Catch?
The model seems ideal, but are there any drawbacks? If you trade through a licensed ECN, there is no need to worry about privacy or security of your deposits. However, the fees may be substantial in the long term, as they are charged on a per-trade basis. The costs will largely depend on the frequency and volume of your trades.If an instrument (for instance, an exotic currency pair) is not liquid enough, the system may struggle to find a match for the order. This results in delays and a possible change in the asset price. This phenomenon is known as slippage. It may work for you or against you. Slippage is possible with market makers, too.
