At the end of Globe War II, the entire world was in such disarray that the major Western countries felt compelled to devise a mechanism to stabilize the global economy.
The accord, known as the “Bretton Woods System,” established the US dollar’s exchange rate against gold. This enabled all other currencies to be tied to the US dollar.
This maintained exchange rates for a while, but as the world’s major economies began to shift and grow at various rates, the system’s rules quickly became outmoded and restricting.
Soon after, in 1971, the Bretton Woods Agreement was repealed and replaced by a new currency value system. With the US in command, the currency market evolved into a free-floating one, with exchange values governed by supply and demand.
It was difficult to ascertain fair exchange rates at first, but developments in technology and communication made things easier in the end. Banks began developing their own trading platforms in the 1990s, courtesy to computer nerds and the rapid rise of the internet.
These systems were created to provide live quotes to their clients, allowing them to conduct transactions immediately.
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Meanwhile, some astute business minds launched internet-based trading platforms for individual traders.
These “retail forex brokers” made it simple for individuals to trade by permitting smaller trading quantities.
In contrast to the interbank market, where the standard deal size is one million units, retail brokers permitted people to trade as few as 1000 units!
Retail Forex Brokers
Previously, only large speculators and highly financed investment funds could trade currencies, but this is no longer the case owing to retail forex brokers and the Internet.
With little entry hurdles, anyone could call a broker, establish an account, deposit money, and trade forex from the comfort of their own home.
Brokers are classified into two types:
1. Market makers, as their name suggests, “make” or set their own bid and ask prices themselves and
2. Electronic Communications Networks (ECN), who use the best bid and ask prices available to them from different institutions on the interbank market.
Market Makers
Assume you wanted to go to France to eat snails. To conduct business in the country, you must first obtain some euros by visiting a bank or a local foreign currency exchange office.
You must agree to convert your local currency for euros at the price they specify in order for them to take the other side of your transaction.
There is a catch, as there is in all business transactions. It takes the shape of the bid/ask spread in this scenario. For example, if the bank’s bid (buying price) for EUR/USD is 1.2000 and their ask (selling price) is 1.2002, the bid/ask spread is 0.0002.
Although relatively insignificant, when millions of these currency transactions occur every day, it adds up to a sizable profit for market makers! Market makers could be considered the essential building pieces of the foreign currency market.
Retail market makers supply liquidity by “repackaging” large contract sizes from wholesalers into smaller parts. Without them, the ordinary Person will struggle to trade forex.
Electronic Communication Network
Trading systems that automatically match users’ buy and sell orders at predetermined prices are referred to as ECNs. These prices are compiled from various market makers, banks, and even other traders who utilize the ECN.
When a sell or purchase order is placed, it is matched to the best bid/ask price available.
Because traders can set their own pricing, ECN brokers often charge a VERY little commission for trades.
Transaction expenses for ECN brokers are often lower due to the combination of tight spreads and low commissions.
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