After World War II, the entire world was in a state of chaos. The economy of all countries has lost its balance. So, the major Western banks felt that they had to come up with a system to stabilize the global economy. Hence, they established the Bretton Woods System, an agreement which set the exchange rate of the US dollar against gold. It also allowed all other currencies to be attached with and against the US dollar.
This system did stabilize the exchange rates for a while, but as other major countries began to grow at their own pace, this system became quite outdated and inefficient.
As a result, the Bretton Woods System was abolished and replaced by a different valuation system for the currencies.
With the US in the driver’s seat, its currency market was replaced to a free-floating type, where the currency rates were determined by demand and supply.
In the initial stages, it was difficult for market players to determine fair exchange prices. But, with the evolution of technology and communication, things got better progressively.
During the last decade of the 1900s, the internet made its entry into the world. This enabled the banks to create their own trading platforms. These trading platforms tremendously benefitted the people as it streamed live quotes to their clients and provided the facility to execute trades instantly.
Later came the “retail forex brokers” who made it simple for individuals to trade with smaller trade sizes. It allowed the individuals to trade with as little as 1,000 units.
Retail Forex Brokers
As mentioned in the previous lessons; back then, only the players with loads of capital could trade in the forex market. But this wasn’t the case anymore because of the facilities provided by the retail forex brokers.
Nowadays, opening a trading account is as easy as opening a regular bank account.
There are two types of brokers in forex:
Electronic Communication Networks
As the name suggests, market makers are the ones who “make” the market. They set both buying price (bid) and the selling price (ask) on their system and display the quotes to the public. They stand prepared to make transactions at their offered prices.
Now, you must be wondering how they would make a profit. Well, they make a profit from the bid/ask spread.
For instance, if they set the bid price for EUR/USD as 1.4000 and ask price as 1.4002, the bid/ask spread becomes 0.0002. And this spread is basically their profits. Although the spread is small, when the millions of transactions are made, they end up making hefty profits.
Market makers also provide liquidity in the market by breaking down large contract sizes from the big players into small sizes to the retail traders.
Hence, we can say that market makers are the fundamental building block of the Forex market.
Electronic Communication Network
Electronic Communication Network (ECN) is a form of trading platform that automatically matches the client’s buy and sells orders at their (client’s) stated prices. These stated prices are gathered by the ECN from different market makers, banks, and even other traders who are trading via the ECN.
Moreover, since the prices are set by the traders themselves, ECN brokers usually charge a tiny commission for the trades. Hence, this makes the transaction costs cheaper on ECN brokers.