Technological advances have made it possible for retail investors to trade the financial markets securely and efficiently, much like the large financial institutions. The Electronic Communications Network (ECN) is one such facility, a computerised system that automatically matches buy and sell orders for market securities.
An ECN broker provides clients direct access to other market participants, through interbank trading systems, such that buyers and sellers are able to find counterparties for their trading positions, without the need of middlemen.
Consider it as a marketplace, where clients can put their bids and offers into the system and interact with other players to find the best prices for trade execution. This not only makes trading efficient and fast, but also expands the geographical reach of market players.
Before we go into ECN in depth, here’s a look at the different types of forex broker models that exist in the market today.
Market Makers, as the name suggests, “make the markets.” They set bid and ask prices on their own systems, which are displayed on their platforms for investors to trade on. A market maker will not hedge their client positions with other liquidity providers, paying winning client positions from their own pockets. Hence, a market maker will always be on the opposite side of the client’s trades. In case the client wins, they lose. In short, such brokers’ interests are not aligned with that of their client.
Now, forex brokers who are not market makers will either be ECN brokers or Straight Through Processing (STP) brokers, collectively known as non-dealing desk brokers. The STP broker will route client orders through the market. But there is a certain complexity in this situation. Sometimes, STP brokers can start acting like market makers, particularly for small clients or losing trades.
STP brokers who follow the Direct Market Access (DMA) model are preferable. They pass on client prices directly to their liquidity pools, so that orders are filled at the best prices. Brokers will charge a small mark-up spread. Brokers offering variable spreads are again preferable, since they choose the best bid price from their own liquidity pool and best ask spreads from another provider.
In this way, an STP broker will have two sources of income: commission arbitrage on routed orders (by much smaller margin than market makers) and losses from unsuccessful client trades. STP broker trades often result in order rejections or re-quotes, given that the prices may have already changed by the time the broker routes orders through the market. So, the broker will either ask clients to adjust the prices or reject the orders straightaway.
An ECN broker, on other hand, never resorts to such price manipulation or slippage practices. They source prices from different liquidity providers, comprising big banks, hedge funds and large financial institution, and always offer the best possible spreads to clients. Requotes are not possible, since all the players interconnect to find counterparties, for every order that remains unfilled internally.
Firstly, ECN brokers usually have minimum capital requirements. Clients can not only see the bid and ask prices, but also the trade volumes on either side of the price, commonly known as “market depth levels.” This is a significant ECN feature. They offer the tightest spreads, sometimes starting as low as 0.0 pips.
ECN brokers offer the maximum transparency and efficiency. Traders get better prices and cheaper trading conditions. Brokers earn their income from fixed commissions per transaction. The higher the trading volume of clients, the greater will be the broker’s profitability. And, under no conditions will an ECN broker trade against the client.
The word “true” is important here, since there are some who claim to be ECN brokers, but actually use the STP model of trading. True ECN brokers don’t mark-up their spreads at all. Any mention of a dealing desk on the broker’s website means they are not actually ECN brokers.
Clients will always get the best possible price available in the market. As stated earlier, spreads on liquid currency pairs such as EUR/USD and GBP/USD are often as low as 0.0 pips, especially during the London and New York sessions. Benefits of trading with such a broker include:
With all that said, not all traders are likely to find benefits in ECN trading. The minimum lot sizes for ECN trading are capped at 0.1 lots. Very few liquidity providers allow lot sizes lower than this limit.
Beginners are usually unable to opt for ECN execution, due to high minimum deposit requirements, larger lots and the model’s inter-banking nature. For them, many firms have adopted a hybrid model of STP+ECN.
Fees and commissions are higher than for non-ECN trading systems. This can hurt the bottom lines of traders, since moderate spreads mean earnings will be lower than fees paid.