Many forex brokers tend to entice new trades by offering high leveraged margin accounts. Now anyone can open a forex trading account with a retail forex broker and trade currencies with little money upfront.
There are basically two types of forex brokers: 1) Market Makers and 2) Electronic Communications Networks (ECNs). Market makers set the bid and the ask prices themselves.
Market making is a lucrative business for banks and brokers and forms the backbone of market liquidity. ECNs consolidate the various bids and ask prices from the different market makers and other participants connected to their platforms and display the best available prices.
Market makers are essentially providing liquidity and inviting other qualified parties like banks, hedge funds, corporations and retail investors to deal with them by quoting the bid and ask prices on the screens of electronic brokering platforms or through telephone calls.
Some market makers establish credit lines with banks that trade on the interbank market. Market makers must always be prepared to buy or sell from other market participants. They also access the Electronic Brokering Platforms like the EBS and the Reuters for pricing.
Market makers make profit from the difference between the bid/ask spread. The bid/ask spread is the difference between the price at which the market maker will buy (bid) and the price at which the market maker will sell at (ask) from the customer interested in foreign exchange.
During the period of high liquidity in which there is a great deal of trading activity, bid/ask spreads of the actively traded currency pairs are usually kept quite narrow like 1-4 pips.
However, when the market is quiet with very little trading going on for example prior to New York close on Fridays or during the news releases, bid/ask spread may widen sometime by a huge margin. Market makers widen the spread in order to protect themselves against carrying additional risks.
ECNs are highly popular in stock trading as well as futures trading. ECNs are electronic trading platforms that match the buy and sell orders automatically at the specific prices.
In an ECN, the order is routed to the best available bid or ask price for execution in the system. An ECN broker gets its currency pricing from several liquidity providers such as banks, market makers or other traders connected to the system.
ECN brokers usually charge a small commission. However, you can usually get tighter spreads on many currency pairs due to the large liquidity pool available with the ECNs. Risk of trade manipulation is also minimized when using a good ECN broker as compared to the brokers that operate dealing desks.
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