What’s the Difference Between a Market Maker and an ECN?
Regarding market makers: some are good, even very good; many are awful.
ECNs have their own issues -- 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 even to mini-accounts. How they bundle 10k lots into a 250k bank lot without intervention, I have not fully determined and, quite honestly, probably do not want to know.
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 books 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? ECNs may also act as a counterparty. But here -- at least in theory -- it is supplemental to their primary duty of trade matching.
Market makers set, manipulate, or control pip spreads, usually as legitimate operations of the market-making process to maintain an orderly market; 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, and 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. All of this said, if you like to trade the minor or exotic currency pairs you will probably get a better deal from a reputable market maker than and ECN. The market maker provides liquidity to these pairs that are many times not available to the trade-matching ECN.
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 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."
By Michael Duane Archer