At the end of the World War II, the whole world was experiencing so much chaos that the major Western governments felt the need to create a system to stabilize the global economy.Known as the “Bretton Woods System,” the agreement set the exchange rate of all currencies against gold.
This stabilized exchange rates for a while, but as the major economies of the world started to change and grow at different speeds, the rules of the system soon became obsolete and limiting.
Soon enough, come 1971, the Bretton Woods Agreement was abolished and replaced by a different currency valuation system. With the United States in the pilot’s seat, the currency market evolved to a free-floating one, where exchange rates were determined by supply and demand.
At first, it was difficult to determine fair exchange rates, but advances in technology and communication eventually made things easier.
These platforms were designed to stream live quotes to their clients so that they could instantly execute trades themselves.
Meanwhile, some smart business-minded marketing machines introduced internet-based trading platforms for individual traders.
Retail Forex Brokers
With hardly any barriers to entry, anybody could just contact a broker, open up an account, deposit some money, and trade forex from the comfort of their own home. Brokers basically come in two forms:
- Market makers, as their name suggests, “make” or set their own bid and ask prices themselves and
- Electronic Communications Networks (ECN), who use the best bid and ask prices available to them from different institutions on the interbank market.
Market Makers
Let’s say you wanted to go to France to eat some snails. In order for you to transact in the country, you need to get your hands on some euros first by going to a bank or the local foreign currency exchange office. For them to take the opposite side of your transaction, you have to agree to exchange your home currency for euros at the price they set.Like in all business transactions, there is a catch. In this case, it comes in the form of the bid/ask spread.
For instance, if the bank’s buying price (bid) for EUR/USD is 1.2000, and their selling price (ask) is 1.2002, then the bid/ask spread is 0.0002. Although seemingly small, when you’re talking about millions of these forex transactions every day, it does add up to create a hefty profit for the market makers!
wholesalers into bite size pieces. Without them, it will be very hard for the average Joe to trade forex.
Electronic Communications Network
Electronic Communication Network is the name given for trading platforms that automatically match customer’s buy and sell orders at stated prices. These stated prices are gathered from different market makers, banks, and even other traders who use the ECN. Whenever a certain sell or buy order is made, it is matched up to the best bid/ask price out there.Due to the ability of traders to set their own prices, ECN brokers typically charge a VERY small commission for the trades you take. The combination of tight spreads and small commission usually make transaction costs cheaper on ECN brokers.