Many retail forex investors dabble in foreign currency trading with hardly any idea whether the forex broker they are dealing with is an ECN broker or a market maker.
They never really cared about what type of broker they transact business with because in the first place, they are not even aware of the difference between the two; much less know for a fact that there exist these two general types of brokers.
Worst, they never realized that their choice of a broker is of utmost importance to their trading adventure and may even spell the difference between making money, losing their capital altogether trading the currencies.
The Era of the Dealing Desk Brokers belongs to the past
It was almost 3 decades ago when retail forex brokers first appeared in the forex arena with a promise to provide individual investors access to foreign exchange. The forex market was up to that point in time, the exclusive turf of large financial institutions, central banks, and giant multinational corporations.
It was known as the era of the dealing desk brokers because non-bank forex dealers mimic the banks’ foreign exchange transactions and created their own dealing desks to process their clients’ currency trading needs.
Sadly, however, individual forex traders were totally at the mercy of their brokers who usually acted as the counterparty to their trades. The conflict of interest was undeniable and yet these brokers were able to fleece the unsuspecting investors for a long while.
Most if not all of them were operating like bucket shops pocketing losses incurred by their own clients in the course of their trading.
The advent of breakthrough technology has revolutionized communications banks and brokers and gave birth to the creation of various electronic communication networks (ECN) which modern day brokers now use to connect to a host of liquidity providers and stream the interbank market rates in real time. This ended the dealing desk era that was lorded over by unscrupulous bucket shop operators as all brokers started to embraced the new technology which offered a more efficient way of connecting to the interbank foreign currency market through electronic communications networks which were specifically created for this purpose and in real time.
The Birth of the ECN Broker
The first electronic communications network was the Instinet which was created for New York’s NASDAQ stock exchange in 1969.
The foreign exchange market followed suit and began creating their own networks that stream interbank rates in real time coming from top tier financial institutions of the foreign currency market.
It was not long before all forex brokers discarded their dealing desks and replaced them with electronic systems that allowed their clients instant access to the broker’s liquidity providers’ quotes.
Others developed their own proprietary systems while others used established and well-known third-party platforms to connect to their liquidity providers in real time.
The emergence of the ECN broker was believed to finally eliminate the conflict of interest between brokers and their clients. Through an electronic communication network, a true ECN broker simply passes all orders from its clients to liquidity providers in the same network and does not trade against them.
They are content in making money through commissions they charge their clients with in exchange for providing access to other market participants. Because of this, the clients are able to avail of tighter bid/ask spreads from various top tier liquidity providers.
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