The foreign exchange market is the largest decentralized market with no physical location for traders to buy and sell currencies. As a result, the interbank market was formed to let big banks and financial institutions to trade currencies between themselves.
Even though the interbank market is made up of big names, this does not mean that retail traders are barred from trading forex. To do so, individuals have to trade through these two main types of brokers: Electronic Communications Network (ECN) and Markets Makers.
To put it in layman’s term, these two types of brokers offer service for traders to trade currencies, but handle and process traders’ trades differently.
Electronic Communication Network (ECN) brokers pass on prices from multiple market participants, such as banks and market makers to display the best bid/ask quotes on their trading platform. By ensuring traders’ trades flow directly to the best price offered by a liquidity provider, ECN brokers get to establish a long-term and trustable relationship with their clients.
Unlike ECN brokers, market makers stand prepared to make transactions by setting the exchange rates based on their own best interests for their traders. It takes the opposite side of the trade. In other words, whenever you sell, they must buy from you and vice versa.
How does it work?
As an example, John goes to a used car dealer shop to get his car sold.
Car dealer A (Market Maker) bought his car right away after John agreed to the bid price they offered. Meanwhile, Car dealer B (ECN broker) helps John to sell his car by sending his offer to other car dealers (big banks and institutions) and potential buyers (retail traders) on the market to ensure John gets the best price.
Needless to say, a Forex broker’s business model is an important factor in a trader’s decision-making process. Hence it is crucial for traders to weigh the pros and cons of each broker before deciding which one to trade through.