ECN Brokers Explained: How They Work & Benefits

An ECN broker is a type of foreign exchange brokerage that uses an Electronic Communications Network (ECN) to match buy and sell orders in the currency exchange trading market. The ECN is essentially a computerized trading system that automatically matches various orders between buyers and sellers in the forex (foreign exchange) market.

In addition to matching buy and sell orders in the market, the ECN provides current buy and sell price quotes that show the highest bid price and lowest offer price currently available in the market for each forex trading pair.

Trading pairs consist of one currency priced against another currency. For example, the trading pair EUR/USD reflects the value of the euro in relation to the U.S. dollar.

The forex market is, by dollar volume traded, the largest financial market in the world. However, forex trading does not occur through exchanges like stocks are traded, but through an over-the-counterOver-the-Counter (OTC)Over-the-counter (OTC) is the trading of securities between two counter-parties executed outside of formal exchanges and without the supervision of an exchange regulator. OTC trading is done in over-the-counter markets (a decentralized place with no physical location), through dealer networks. market via which buyers are connected with sellers.

Summary

• An ECN broker is a forex broker that directly connects buy and sell orders through an electronic communication network (ECN).
• ECN brokers offer faster execution of orders and usually at more favorable prices.
• The alternative to an ECN broker is a dealing desk broker; one major problem that dealing desk brokers present for traders is that of requotes.

Characteristics of ECN Brokers

• An ECN broker executes trades over the ECN for potential investors. Because of the way an ECN operates, dealing with such types of brokers also results in lower costs and more trading time.
• ECN brokers do not move the influx of orders to market makers. Rather, they electronically match the participants in a trade and transfer the orders to intermediaries in the securities markets.
• An ECN broker is prohibited to trade against its client or clients because it matches transactions amongst market participants. Since ECN spreads are much smaller than those utilized by regular brokers, ECN brokers charge a set commission per transaction to their clients.

ECN Brokers vs. Dealing Desk Brokers

ECN brokers are considered superior to dealing desk brokers because the ECN provides a direct connection between buyers and sellers.

In contrast, dealing desk brokers execute trades by either taking the opposite side of the trade themselves (i.e., they sell to a client who puts in a buy order, or they buy from a client who places a sell order) or by passing on the order to a market maker.

Dealing desk brokers are criticized on two counts. First, if they are taking the opposite side of client trades themselves, they are essentially making investments counter to those of their clients, which at least potentially creates a conflict of interest. Also, if they are passing orders on to a market maker, that makes for slower order execution, which can result in clients’ orders being filled at less favorable prices.

Advantages of ECN Brokers

ECN brokers offer forex traders the following advantages:

Lower bid and ask spreads

When buying or selling financial assets, there is always a spread differential between the best available buy and sell prices. A buyer needs to pay the best available sell price offered (the “ask”), while a seller must take the best available buy price (the “bid”).

Because an ECN instantly matches orders from traders with the best available buy and sell prices from all participants in the forex market, this typically results in tighter bid-ask spreads.

Thus, traders can enter or exit positions in the market at more favorable prices than what will be available through a dealing desk broker. Dealing desk brokers usually offer higher bid and ask spreads, as they make their money by pocketing part of the spread for themselves.

Flexibility

ECNs allow for clients or investors to be able to participate and facilitate trades in market exchanges, outside the normal trading hours.

Speed

Trades are carried out immediately and at significantly thinner spreads. Many separate providers of liquidity are vying for orders to trade. It motivates them to deliver the lowest possible rates in a bid to beat the competition and attract traders.

Flat commission rate

Instead of making money off the bid-ask spread, ECN brokers usually charge a flat commissionCommissionCommission refers to the compensation paid to an employee after completing a task, which is, often, selling a certain number of products or services rate on each trade.

A Caution for Traders

There are hundreds of forex brokerage firms operating worldwide. Many are not regulated by any financial authority. Some of these unregulated brokers claim to be ECN brokers but are, in fact, dealing desk brokers.

The only way to make sure that a forex broker is a true ECN broker is to make sure that you are trading with a regulated broker. Any regulated brokerage firm will provide information regarding its regulated status on its website.

Another way to ensure that you’re dealing with a genuine ECN broker is that ECN brokers do not present traders with the problem of requotes. Requotes occur due to the slower execution of dealing desk brokers.

A trader may enter an order to buy or sell at the current market priceDepth of Market (DOM)Depth of Market (DOM) is a window that displays the real-time market activity at different price levels in a security or currency market. DOM is also known, but instead of having his or her order instantly filled, they are presented with a requote at a new market price.

The delays in order execution caused by requotes can cost traders significant money or, in a rapidly moving market, prevent them from being able to execute a trade at all.

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