The forex market, where you can now buy and sell currencies belonging to nearly any of the world’s economies, strengthened as the largest and most liquid marketplace owing to the ECN brokers. Traders process their transactions with brokers, who are essentially the middlemen, to match orders in the market. To that end, there are two major types of brokers, the traditional kind of broker, called a market maker, and ECN brokers.
ECN broker explained
ECN means electronic communications network. Essentially, it is an automated network that enables forex traders to access the forex market directly. On the network, the different market participants are brought together such that traders can see the various sources of the currencies they intend to trade.
The mode of operation of these brokerages does not involve a dealing desk. What this means is that there is no middleman between you as a trader and the source of the currency you intend to purchase. This way, you can see the different providers and their quote prices, which enables you to choose the best price at any given time.
More often than not, ECN brokers do not charge spreads to traders. They display all orders from these traders and match orders, essentially acting as a facilitator for the trades. In return, they take their pound of flesh in the form of a fixed commission per trade.
ECN brokers vs. market makers
The traditional brokerage system involves a broker operating a dealing desk execution system. This means that the broker quotes their own bid and ask prices on their platform, essentially making the market. These prices are all their clients can see. The difference between these two prices is the spread, which is how these brokers make money.
Since market makers do not obtain their pricing from other liquidity providers, they essentially take the other side of traders’ transactions. This means that every winning trade their client makes is paid out of their own pocket. With this dynamic, it is easy to see the conflict of interest between such brokers and their clients.
ECN brokers, on the other hand, bring all market participants together in one platform, essentially forming an auction for currencies. This way, the traders themselves can obtain the best prices in a more transparent manner.
Why choose ECN?
For one, an ECN broker will not take up the opposite position of client transactions. Their only function is to bring all market participants together in one platform. They earn their fees through commissions, which means they stand to make money whether you win or lose. This way, the conflict of interest common with market makers is eliminated.
Further, the pricing provided by ECN brokers is transparent. On the platform, traders can see the prices from different liquidity providers, as well as historical prices of the asset they’re trading. Market makers often adjust their prices in the middle of executing orders, especially during periods of high volatility. This is referred to as re-quoting. Additionally, due to a large number of sources for quotes, you can easily obtain better prices and tighter spreads than in the traditional brokerage setup.
Advantages of using ECN
- Direct access to market participants and liquidity providers allows you transparent and much more competitive pricing.
- The transparency in pricing eliminates the risk of brokers manipulating prices for their own gain.
- It ensures the anonymity of trades, which is especially vital to large-volume traders who value their privacy.
- It eliminates the problem of re-quotes common with conventional brokers. This is due to the instant nature of trade execution.
Disadvantages of ECN
As aforementioned, ECN brokers charge a commission per trade, which is the cost of using their services. Sometimes, especially for large-volume traders, this may prove more expensive than the spread system. Therefore, before executing a trade through an ECN broker, factor in their commitment to ensuring you’re not going the more expensive route with your trade.
Further, ECN platforms can be confusing, especially to novice traders. The abundance of quotes from different sources may be too much for a trader who is not familiar with the workings of the FX market. In addition, prices are always fluctuating as the market moves, which may make it difficult to formulate a strategy and carry out effective risk management.
What kind of traders are best suited for ECN?
Essentially, ECN can be a suitable fit for all kinds of traders. The low prices and transparent charges, coupled with instant trade execution, is a lucrative offer for most traders. Day traders especially, who benefit from small price swings throughout the day, may benefit from this sort of arrangement.
Further, ECN brokers offer 24-hour access to the markets, even when the relevant session is closed. This may benefit traders who want to trade currency pairs during their periods of inactivity. For instance, if you want to trade the AUD from the US, you do not have to wait for the Australian session to open. You can use ECN brokers who will match you with liquidity providers for that currency.
In a nutshell
ECN brokers offer an automated platform on which they pool liquidity providers, traders, and other market participants on the same platform. This way, traders can obtain quotes from different sources, allowing them to go with the lowest bidder for purchases and the highest bidder for sales. These brokers charge a fixed commission as opposed to variable spreads, which further contributes to their transparency.
However, sometimes these commissions may prove costlier than spreads. Further, due to a large number of participants, ECN platforms may be confusing to beginners in the forex trade. Prices constantly fluctuate, which may overwhelm a trader who is trying to come up with a trading strategy or place a stop loss. Therefore, this brokerage method is recommended for experienced traders.
