An ECN (electronic communication network) is a technology-based venue incorporating numerous liquidity providers (LPs), both bank and non-bank, who continuously stream their pricing to the ECN.
The ECN will, in turn, aggregate the pricing. When viewing the entire depth of the aggregated price feed of electronic communication networks, you will notice that it has many levels of liquidity.
Liquidity Providers prefer to stream smaller ticket size pricing to the ECNs due to the fact that this allows them to provide tighter spreads knowing that they aren’t at risk of getting hit with large tickets on those spreads.
The LPs are also aware that, by pricing competitively, they have a chance of being “Top of Book” (ToB) and can win business from competitors in the space.
The end result is a very tight ToB.
Advantages and Disadvantages of Electronic Communication Networks
The use of the ECN allows investors a way to trade outside traditional trading hours, providing a mechanism for those who either can’t be actively involved during normal market times or who prefer the flexibility offered by wider availability. It also avoids the wider spreads that are common when using a traditional broker and provides overall lower commissions and fees. For those concerned about privacy, the ECN can provide a level of anonymity to those who desire it. This can be particularly attractive to investors interested in making larger transactions.
One of the biggest drawbacks to using an ECN is the price to pay for using one. Access fees and commission charges can be costly and difficult to avoid. Per-trade-based commissions can be costly and can affect your bottom line and profitability.
Another disadvantage of using ECNs is that the platform is less user-friendly than those provided by traditional brokers. Furthermore, the lack of integrated charts and data traditional brokers provide on their interfaces may make it difficult for beginner investors.
Finally, the wider spreads may complicate the process of calculating break-even and stop-loss points for some investors.
Allows investors to trade outside traditional trading hours
- Provides wider spreads than traditional brokers
- Less user-friendly platforms than traditional brokers
- Harder to calculate break-even points because of wider spreads
Along with ECNs, matching systems and call markets are also considered forms of alternative trading systems. Matching systems receive orders and route the activity through a matching engine instance where the prices are checked against current resting limit orders. If no match is found, the order is placed in the book immediately as a quote. Call markets accept orders one at a time, with buying and selling prices determined based on the exchange activity after the order is placed.
Examples of ECNs
Some of the different ECNs include Instinet, SelectNet, and NYSE Arca. Instinet was the first ECN, founded in 1969, and is used by small brokerages and for transactions between institutions.2 It is widely used by market makers for NASDAQ trades, but individuals and small firms can also use it.
SelectNet is used primarily by market makers, but it does not require immediate order execution and helps investors trade with specific market makers. NYSE Arca grew out of the merger between the New York Stock Exchange (NYSE) and Archipelago, an early ECN from 1996.3 It facilitates electronic stock trading on major U.S. exchanges such as the NYSE and NASDAQ.
In foreign exchange markets, certain Forex brokers are designated as ECN brokers who can facilitate currency trades across electronic matching networks.
ECNs vs. Market Markers
The term market makers refer to high-volume traders that literally “make a market” for securities by always standing at the ready to buy or sell. Unlike ECNs, market makers profit on the bid-ask spread rather than through commissions and fees. similar to ECNs they benefit the market by increasing liquidity.
Market markers set both the bid and the ask prices on their systems and display them publicly on their quote screens. The spread is typically kept lower than that investors can find in ECNs due to the fact that market makers generate their profit via the spread.
Without market makers and ECNs, it would take considerably longer for buyers and sellers to be matched with one another. This would reduce liquidity, making it more difficult to enter or exit positions and adding to the costs and risks of trading.
ECN Trading FAQs
How Do You Use an ECN in Forex Trading?
ECNs are computer-based programs that connect retail forex investors with major brokerages, all around the clock. After logging on to the ECN platform, investors will see the best available bid and ask quotes displayed from multiple market participants. ECNs will automatically match and execute orders.
How Are ECN Trading Fees Calculated?
Electronic communication network (ECN) fees are applied on a per-trade basis, usually fractions of a cent. ECNs charge a service fee for matching buyers and sellers who trade on their exchanges and networks.
How Do I Open an ECN Trading Account?
To open an ECN trading account, simply create an account at one of the many ECN trading platforms available best suited to your needs. GO Markets, Exness, and XM are some of the most popular platforms.
What Is the Difference Between Straight-Through Processing (STP) and ECN?
Whereas ECNs provide liquidity by connecting investors with a number of parties—whether brokers or other retail investors—in order to complete a trade, STP brokers are automated brokers that provide traders with the ability to skip the middle man, but only through select liquidity providers.