One of the more popular ways active forex traders prefer to access the currency market is via an online broker that uses an electronic communications network (ECN). An ECN provides a rapid connection between retail forex traders and liquidity providers like major commercial banks and other financial institutions that act as market makers.
In practice, an ECN forex broker uses a proprietary computerized system to collect and summarize the best exchange rate quotes for the various currency pairs from among a variety of participating market makers. The trading system then executes buy and sell orders submitted by the broker’s clients by matching them with the best exchange rate currently available to the system.
In the following article, Benzinga explains what electronic communication network trading is and suggests whether using an ECN can be advantageous to your forex trading activities.
How Does an Electronic Communication Network (ECN) Work?
When implemented by online brokers serving the retail forex market, an ECN receives exchange rate quotes and the amounts they are good for that were entered into the system by participating market makers via a computer terminal. The ECN selects and displays the best current bid and offers quotes derived from its network of market makers at any particular time.
ECN algorithms operate at high speeds of less than 100 milliseconds as they check quote size limits and match orders with quotes for execution. Trades also take place automatically within the ECN system.
The broker using an ECN will receive different types of buy and sell orders, like limit orders for example, from its retail trading clients, and its ECN algorithm will then automatically match those orders with the best quotes for their execution.
To help maintain client privacy, an ECN broker lists itself as the counterparty on trades executed via the network. This setup means that all client trades remain anonymous to the quoting market makers and in execution reports.
Trading forex through an ECN broker basically removes the middleman and its extra associated costs and execution risks since the ECN lets traders deal on quotes coming directly from Interbank forex market markers. This practice can notably reduce transaction costs and help eliminate most human errors.
Retail forex traders often prefer to use an ECN to get the best composite quote coming from the range of market makers their ECN broker uses. This process lets them access tighter dealing spreads and the best exchange rate available among those market makers for their orders.
Since an ECN broker provides its clients with access to the electronic network of market makers instead of a more traditional dealing desk, it is also known as a no dealing desk (NDD) broker. ECN brokers typically make their money either by charging a per-trade commission or by slightly widening the tight dealing spreads the ECN.
Since all ECN transactions take place automatically, trades get executed quickly, generally without requotes or order slippage. Because of the highly competitive and liquid nature of the Interbank forex market, ECNs display tight dealing spreads of 1-2 pips for most major currency pairs. These include U.S. dollar pairs like EUR/USD, USD/JPY, GBP/USD, USD/CHF, AUD/USD, NZD/USD and USD/CAD, and the major euro crosses.
Popular Electronic Communication Networks
ECNs have been used in the stock market for many years and are classified by the U.S. Securities and Exchange Commission (SEC) as alternative trading systems (ATSs). Some examples of ECNs that facilitate stock trading include Instinet, SelectNet and NYSE Arca.
In the retail forex market, ECNs are set up by an online forex broker to facilitate order executions for its clients. These proprietary electronic networks generally show the best available exchange rate quotes compiled from a variety of professional market makers active in the Interbank forex market that the broker has established a dealing relationship with.
These market makers include traders operating at major commercial banks and other financial institutions whose exchange rate quotes for the various currency pairs and the amount those quotes are good for are entered via a computer terminal to populate the ECN.
You can generally open a demo account with online forex brokers to test out their trading platforms, the speed of their ECN and their other product offerings that might aid your forex trading business.
Trading with ECN Brokers
An ECN broker uses an electronic communication network to route its clients’ orders to a selection of market makers operating in the Interbank forex market. If you are a retail forex trader, then opening a margin trading account with this type of online forex broker has various advantages and some disadvantages that are summarized in the bullet points below.
Pros
- No requotes on orders
- Low transaction costs
- High liquidity
- Tight dealing spreads
- No conflict of interest
- No reading the client since the ECN does not know the client’s positioning
- No order slippage
- Transaction anonymity
Cons
- Traders don’t get the personalized service that a dealing desk broker can provide.
- Micro-lot trading may not be offered by an ECN broker.
- The fixed per-trade commission charged on trades made in an ECN account might exceed the cost of trading on a wider dealing spread in a normal account.
- Initial margin deposit requirements for ECN accounts can be higher than normal.
In addition to looking for tight dealing spreads from an ECN forex broker, you will also want to make sure that it is a well-regulated and reputable dealing partner that will safely hold your margin deposit.
Should You Use an ECN Broker?
Using an ECN broker generally makes the most sense if you are an experienced forex trader who wants access to the best possible dealing spreads and does not need access to a wide range of educational resources that many ECN brokers skimp on.
An ECN broker can also help reduce your trading costs substantially. This benefit would be especially important to you if you use a short-term trading strategy like scalping where you will be actively trading in significant amounts to capture many small gains.
Optimizing Trading Activities
ECNs have revolutionized the forex market by providing direct access to liquidity providers and Interbank forex market makers. They eliminate middlemen, offer tight spreads and reduce transaction costs and human error. While they may lack personalized services and have higher margin requirements, they can be ideal for experienced traders seeking efficiency and the best rates. Embracing a reputable and regulated ECN broker allows traders to optimize their activities and capitalize on the advantages of electronic communication networks.
Frequently Asked Questions
Is ECN an exchange?
No, an ECN is considered an alternative trading system instead of an exchange. In the forex market, an ECN consists of an electronic network organized by a particular online forex broker that displays quotes from several market makers. Transaction anonymity is typically preserved with an ECN since the market makers usually deal with the broker that then trades with their client instead of dealing with the client directly.
What does ECN stand for?
ECN stands for electronic communications network. Online forex brokers often set up a proprietary ECN to give their active clients access to the tighter dealing spreads available in the Interbank forex market.
What is an example of an ECN?
Many online forex brokers operate their own proprietary ECNs to service their clients better by providing tighter dealing spreads compiled from a range of market makers. Some examples of public ECNs that facilitate stock trading include Instinet, SelectNet and NYSE Arca.