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| ECN vs. Market Maker |
Contrary to popular belief, ECN's are not superior
to Market Makers in every way. There are
advantages and disadvantages on both sides.
Minimum Deposits
There are retail market makers out there
today that allow traders to begin with $1 in their
accounts. That’s not to say that this is a great
feature, but it does present options to people who
may not have the kind of money it takes to open a
Currenex account. It’s a good thing too, because
ECN contract sizes are often multiples of $1
million, and some ECNs expect a daily volume of
$25 million. Shackled with those types of
minimums, you had better be well Capitalized (with
a capital “C”).
Leverage
ECNs don’t allow the type of high
leverage that is typical of market makers. To most
people this is no great loss, since it is
generally not advisable to use anywhere near the
leverage that is available at most retail market
makers.
Transaction Costs
Whether they call it a spread or a
commission is really irrelevant at the end of the
day - no matter what, you have to pay to play.
ECNs typically give you the prices they are dealt
from their liquidity providers, with the exact
same spreads, but then charge a commission for
every round turn trade. This allows them to give
discounts to high volume traders, lowering their
costs, but to most traders, it is really
irrelevant whether they are made to pay a
commission with a tight spread or no commission
with a higher spread. It works out to be roughly
the same, depending on which brokers you are
comparing, and what current spreads are like.
Volatility
The potential volatility is higher on
ECNs because of their unfiltered slice of the
market. By risking some exposure, market makers
can generally mitigate this. Depending on the type
of trader you are, volatility may be your friend
or your enemy.
Stability of Business Model
The fact that a market maker is the
counterparty to many of its clients’ trades,
exposes it to market risk. While this risk should
be well managed through appropriate hedging with a
higher-tier counterparty, this may or may not be
the actual case. Furthermore, even if the risk is
well managed, it is still a risk. An ECN does not
have to worry about this, as it provides only a
service for which it charges a commission. At no
point is an ECN exposed to market risk. What this
means is that the likelihood of an ECN becoming
insolvent is much lower than that of a market
maker. This has serious implications for client
funds which the broker is holding. On the other
hand, any market maker worth its salt should keep
client funds segregated from the company’s
operating capital, itself be well capitalized, and
keep risk management tight, therefore keeping
clients relatively insulated against the
possibility of broker bankruptcy.
Susceptibility to manipulation
While ECNs offer a “truer” participation
in the market, the picture there is not
necessarily prettier. The added transparency only
brings to light the dog-eat-dog world that is the
forex market. Trading with a market maker
insulates your from that to some degree, but this
can also be used to hide things from you. It is
nice to have guaranteed stops, though, and you
won’t find those on any ECN. Basically, in my
view, ECNs are great for experienced day traders
and scalpers, while market makers are better for
everyone else, as long as they are deemed to be
"honest".
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