By the finish of the second World War, the whole world was so chaotic that the Western countries decided something had to be done to stabilize the economy.
A system known as the “Bretton Woods System” was put into place. It set all of the country’s exchange rates against gold. This system worked well to stabilize rates for a short time, but as countries began to grow at different rates the system stopped working so well.
In 1971, the Bretton Woods Agreement was thrown out and replaced with a new system that evaluated the value of currency. The United States was in control and the system became one determined by supply and demand. It was hard to figure out fair rates for everyone initially, but advancements in technology helped make it easier to do.
When the 90’s started up, banks began to create their own trading platforms, thanks to the computer nerds, and their newly created internet. These trading platforms sent quotes to their clients who executed their own trades.
Some smart businessmen were in the background working on a system for all of the individual traders out there.
This specialized system, known as “retail forex platforms”, made it possible for individuals to begin trading because they could trade smaller lot sizes. While the interbank requires a minimum amount of a million units, these retail brokers make it possible for trades as small as 1,000 units!
Forex Retail Brokers
While it was only possible for the big players to participate in trading forex in the past, the addition of retail brokers made it possible for any average joe to open up an account and trade from their home. These Brokers come in two different forms:
- Market Makers – the ones who set up or “make” their own bid prices and ask prices.
- Electronic Communications Networks, or ECN’s – use the best bid and ask prices that are made available to them from companies who are on the interbank market.
The Forex Market Makers
Imagine that you want to travel to France to eat some tasty snails. Before you will be able to complete any transactions in the country, you have to trade in your cash for a stack of Euros. To get your hands on those, you will have to visit a local bank or a foreign currency exchange office. To be able to exchange your money, you have to agree to the rate that they set.
Just like with everything else in life, there is a little catch. The bid/ask spread can complicate matters a little bit.
For example, if the banks bid for EUR/USD is 1.3000, and they are asking 1.3003, the spread is .0003. Well it may seem like a tiny amount of money to you and me, when amplified over several million transactions it comes up to a nice little profit for the makers.
The makers lay the foundation for the market of foreign exchange. Retail makers repackage very large sized lots into easily accessible lots and help provide liquidity by doing so. Without them, it would be very hard for Joe Schmoe to trade anything on forex.
Electronic Communications Network
Trading platforms, given the name “Electronic Communications Networks”, automatically match a customer with buy and sell orders at a stated price. These prices are gathered from many different sources such as banks, market makers, and other traders. When a person makes a buy or sell order, they are matched with the closest order out there.
Since traders are able to choose their own prices, ECN’s usually charge a very minimal fee for carrying out your trades. Since the spreads are tight and the commission is very minimal, ECN’s are usually the way to go.
Forextips.com is committed to educating the forex trader in all aspects of foreign currency trading. Click here to get information on a free forex webinar to help you maximize your success in the forex market.