Forex Market Makers

The stock market has brokers – people, or often companies, that offer traders the ability to buy or sell equity in any public company quickly and easily. The commodities market has brokers for an entire range of futures and other contracts, each offering much of the same – the ability to find and buy contracts on the market. The forex market, however, has a slightly different type of broker.

Unlike most brokers, which hold little of their stock in inventory and instead buy and sell from the market itself, the forex world has market makers. These businesses act as a broker, offering a very similar type of service on the whole. However, they differ from brokers in the the trader that they work with are often buying their currencies not from the market itself, but from the market maker.

This means that, effectively, they’re holding particularly currencies as inventory, retaining all of their own currency holdings and subsequently using them as both a currency investment and as a type of instrument that commands brokerage fees. It’s a two-way win for the market maker, and it often becomes an issue – or even a liability – for the forex traders that choose to work with them.

This is made possible because of a major difference between the way the stock market, which is based on exchanges, and the forex market, which is largely unregulated and unconnected to any exchange, operate. Stocks are tied to a particular market value, one that brokers rarely are able to differ from. Currencies, on the other hand, are decentralized and able to be resold at any value.

This allows market makers to purchase currencies at a relatively low rate, often during periods of poor economic performance for a particular country, and resell them as part of their inventory at a higher rate later. It’s a double-hit strategy for the broker – or market maker, in this case – they can sell the currency at an agreeable price and gain a commission, while also gaining a small margin.

Generally speaking, these market makers can be divided into two different categories. For most traders, interaction typically occurs with retail market makers. These market makers buy and sell currencies with anyone – either an ordinary person looking to trade currencies for use as cash, or any type of currency investor aiming to change their cash from one currency into another.

They produce a profit based on the spread of their currencies, which is the gap between the buy and sell price. When you purchase a currency from a market maker in exchange for another – this could mean trading USD for EUR – you’re accepting a lower-than-market rate for your USD, and in turn receiving EUR at a slightly objective loss. In this value spread, the market maker is profitable.

In the aggregate, this type of transaction produces a great deal of profit for the market maker. While their margin may be relatively small – less than three percent of the total value is standard – they’re generally accustomed to processing a huge amount of transactions. This means that their margins are amplified into a lucrative income due to the sheer volume of currency-to-currency trading.

For high-volume investors, this obviously isn’t a good option. The rates that many market makers take make all but the smallest trades a relatively costly process, often wiping out trade margins. As such, many investors prefer to work with a market maker that specializes in high-volume trades. A market maker of this type has a relatively thin bid-ask spread, producing a lower profit margin.

Generally, this type of service is available through banks. Using the second type of market maker – an interbank trade system – banks are able to trade currencies at a relatively low cost. Sometimes, a bank may not sell your currency into another when making a trade. Instead, they may hold it to use as part of another trade, securing a larger margin through their ‘inventory’ of available currencies.

For the most part, this comes off as a negative situation for traders. Not only are they charged a sizable fee for their currency trades – they’re forced to deal with a market maker that accepts an increasingly large margin on all of their trading activity. Despite this, the simplicity and simple accessibility of most market maker trading platforms makes them a popular choice for traders.

These platforms are also generally less volatile than an ECN broker – the type of broker that will trade directly against market currency rates. This is because most market makers update currency values less frequently than ECNS. For brokers, who trade for only minutes – sometimes seconds – at a time, however, this is generally negative, due to the relative decrease in currency volatility.

Sound complex? Don’t worry – while trading currencies can seem complex, it’s actually a fairly simple process. Market makers are accessible – it’s their greatest quality – which makes them a good, albeit expensive, way to enter the world of forex trading.

However, for high-volume traders, currency day traders, and of course, forex scalpers, there are generally better deals to be found with an ECN broker. At the end of the day, it’s up to you – the ideal broker for your investment style may not suit another person. However, in terms of margin alone, it’s often best to avoid market makers in favor of online currency brokers.

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