Know the Benefits of Trading with an ECN Broker
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.
Difference Between Market Maker, STP and ECN Brokers
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.
How to Differentiate Between ECN and Standard Accounts
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.
Advantages of Trading with a True ECN Broker
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:
- Sophisticated communication technology, like the FIX protocol, which sources the best prices from liquidity providers and delivers orders to liquidity providers for execution.
- Highly accessible networks, which remain efficient for FX transactions even for after-hours trading. This allows flexibility to certain traders, who cannot trade during the normal session timings.
- Instant trade execution, live streaming of prices and immediate confirmation of final prices.
- Highly suitable for algorithmic trading or Expert Advisors (EAs), due to high execution speed.
- Certain ECN systems are designed to ensure that even small traders can access the best prices and spreads, just like institutional investors.
- Spreads are much tighter than those offered by standard brokers.
- No price re-quotes and minimal slippage.
- Fixed commissions per transactions.
- Absence of wider spreads means lower fees and commissions, and also additional trading time for clients.
- Price feed transparency. All ECN brokers have access to the same price list at any given time.
- Current and past price data is accessible for participants, which not only facilitates market analysis, but also prevents price manipulation.
- Traders deal on neutral prices, reflecting real market conditions. Prices are never directed towards a trader, based on strategies, market position or size of the order.
- Traders can link their personal trading models and risk management systems to their broker’s price feed, which can help them access a range of other data.
Limitations of ECN Broker
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.