After World War 2 draws to a close, the entire world was wallowing in unprecedented chaos such that it prompted the Western governments to put in place a system aimed at stabilising the global economy. That system became known as the “Bretton Woods System”.
The Bretton Woods Agreement is a financial system that saw the United States Dollars pegged against Gold as the official exchange rate. Thus, the agreement makes it possible for all other currencies of the world to be pegged and rated against the U.S Dollar as the official exchange rate currency of the world.
Of course, the system helped in normalising the exchange rate problem for a while. However, as other vital economies of the world started developing, changing and growing at a different pace, the dictates of the Bretton Woods system eventually became limiting and completely obsolete.
The D-day came in 1972 when the Bretton Woods financial system agreement was finally abolished, and a new currency valuation system took its place.
As U.S influence continues to dominate, the currency market metamorphoses into a free-floating process where demand and supply became the factors that determine exchange rates.
Initially, it wasn’t easy to ascertain equitable exchange rates. But, as technology increase and communications become more innovative, things started going the right way.
The 1990s was an era that saw rapid development in computer nerds and unprecedented growth on the internet (with special thanks to Al Gore), which enables banks and other important financial institutions to develop their independent platforms.
Because of these platforms, banks can stream live quotes to their customers, enabling them to perform instant transactions.
Furthermore, some profit-minded, highly innovative business machines also incorporated internet-based trading for personal traders.
These entities are described as “retail forex brokers”, and their internet-based trading platforms simplify the process for people to do business by creating room for small size trades to thrive.
For instance, while the standard trade size allowed in the interbank market is 1 million units, retail brokers makes it easy for people to trade with as little as 1000 units! You can imagine that.
Talking about retail forex brokers
Before now, it’s only the highly capitalised investment funds and the big specialised banks that have the right to trade currencies. However, with the advent of modern technology and the internet, plus the unique services of retail brokers, things have changed.
Nowadays, there is hardly any restriction. The market now operate an ‘open door policy’ where anyone can easily contact a broker, open an account, put in some cash, and engage in forex trading even from the comfort of their bed.
Basically speaking, there are two forms of brokers.
- Market makers: Just as the name implies, these are the types of brokers that ‘set’ or ‘make’ their bid, including asking prices by themselves.
- ECN (Electronic Communication Networks): These are brokers that utilise the most excellent bid and also inquire about available prices from different institutions operating in the interbank market.
Market Makers
Assuming you want to go to Paris to enjoy some sticks of snails, you will first need to get some Euros so you can make the transaction in that country. To achieve this, you need to visit a bank or go to the office of the local foreign currency exchange. Once there, you will have to agree to the laid down exchange rate between the euro and your home currency.
As it is in all business dealings, there is a catch, and in this very instance, it lies in the form of bidding/asking spread.
For example, if the buying price/rate (which is the bid) of the bank for Euro/USD is put at 1.3000, and their selling price/rate (which is the asking or ask) is 1.3002, then the bid/ask rate/price is the difference of 0.0002.
While the amount in the difference may seem little, think about when you’re dealing with millions of such forex transactions every day, which significantly add up to generate a considerable sum in profit for the market makers.
Therefore, you wouldn’t be wrong if you conclude that the market makers are the pillars of the foreign exchange market.
One thing that retail market makers do traditionally is ‘repackage’ huge contract volumes from wholesalers into pieces of bite sizes to provide liquidity. Without market makers, it would never have been this easy for every Dick and Harry to trade Forex.
Electronic communication network (ECN)
ECN is the name ascribed to trading platforms that automatically match and compares customer’s buy and sell orders at agreed prices.
These agreed prices are pulled from different banks, market makers, including other traders that use ECN.
Each time a particular selling or buying order is initiated, it is matched up automatically to the best bidding/asking price out there in the market.
Considering that traders reserve the privilege of setting the prices they deem fit, brokers that use ECN traditionally charge a tiny commission for any trade you partake in.
Transaction cost is cheaper on ECN due to the combination of small commissions and tight spreads.
That said, it isn’t quite enough to know the big players in the business. To recall what Big Pippin noted some time ago, “Trading requires timing.” Now the question is; do you know EXACTLY when to trade?
