What is an ECN Broker?
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-counter market via which buyers are connected with sellers.
- 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.
What’s Different About an ECN Broker?
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 two primary advantages, which usually make for lower total trading costs for investors, which means higher net profits or lower net losses.
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.
Flat commission rate
Instead of making money off the bid-ask spread, ECEN brokers usually charge a flat commission 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 price, 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.
CFI is the official provider of the global Certified Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful: