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ECN Broker: Definition, Characteristics and Advantages

TABLE OF CONTENTS

ECN Broker: Definition, Characteristics and Advantages

ECN Broker: Definition, Characteristics and Advantages

Vantage Updated Updated Tue, 2022 June 14 07:00

ECN Brokers are some of the most common brokers you’ll encounter during your career as a day or swing trader. Here, we take a deep dive into who they are, how they execute trades, what to expect from them and potential advantages of using their services.

Key Points

  • ECN brokers facilitate direct connections between traders and liquidity providers, offering quicker trades with tighter spreads and a flat commission rate.
  • They provide more transparent and flexible trading conditions without trading against clients, reducing the risk of price manipulation.
  • Traders using ECN brokers can trade outside normal hours, avoid re-quotes, and enjoy direct market executions with immediate confirmations.

What is an ECN Broker? 

ECN brokers are forex (foreign exchange) brokerages that use Electronic Communication Networks (ECNs) – a computerised trading system – to connect buyers and sellers directly without interfering with their relations, matching buy and sell orders automatically.

One distinct characteristic of ECN brokers is that they offer a wide range of price quotes from various liquidity providers.

As a result, traders gain access to platforms where they can choose their preferred bid and ask prices based on their interests, and trim their spreads as much as they want. Moreover, ECN brokers don’t take traders’ spread for themselves, but instead use commissions to finance their services.[1]

Since liquidity providers and traders are directly linked, ECN brokers rarely interfere with their trading processes. Additionally, if the trader’s technical infrastructure works as desired, trading operations begin instantly. This prevents brokers from trading against their clients.

Besides matching buyers and sellers in the market, ECN brokers also provide current bid and offer quotes that indicate the highest buy and lowest sell prices currently available for each trading pair.

It is essential to keep in mind that trading pairs typically consists of two currencies priced against each other. For instance, the trading pair USD/AUD reflects the value of the US dollar in relation to the Australian dollar.

What are the Characteristics of an ECN Broker?

An ECN broker typically offers more affordable prices and is often faster at executing orders. Let’s explore the main characteristics of an ECN broker:

  • ECN brokers execute trades over electronic communication networks for potential investors, resulting in more trading time and tighter spreads.
  • ECN brokers don’t move the influx of trade orders to markets. Instead, they match participants in trades electronically and transfer transactions to securities markets intermediaries. [2]
  • ECN brokers are prohibited from trading against their clients because they usually match orders amongst market participants. Additionally, since an ECN broker typically offers tighter spreads compared to those provided by a regular broker, an ECN broker charges a set commission per transaction.

Dealing Desk Brokers vs. ECN Brokers

Dealing desk brokers are typically considered inferior to ECN brokers because ECN brokers provide direct connections between sellers and buyers.

Dealing desk brokers usually execute trades by either passing them to market makers or by taking the opposite sides of trades themselves (i.e., they buy from clients who place sell orders or sell to clients who put in buy orders).

Most people criticise desk brokers on two factors. First, if they pass orders to market traders, this typically results in slower order execution, which means that orders could be executed at less favourable prices. Also, if they take opposite sides of their clients’ trades; they are actually making investments that counter those of their clients.

What are the Advantages of an ECN Broker?

1. Thinner Buy and Sell Spreads

There’s always a spread between buy and sell prices when trading financial assets. Therefore, buyers must pay the best ask (sell) prices offered, while sellers need to take the best bid (buy) prices.

Because ECN brokers instantly match traders with the best buy and sell prices from various participants in the market, this usually results in lower bid-ask spreads.

Therefore, traders can exit or enter positions in the forex market at prices that are more favourable than what is usually available through dealing desk brokers.

Dealing desk brokers typically offer higher buy and sell spreads primarily because they benefit from the bid-ask spread.[3]

2. Flexibility

ECN brokers allow investors or clients to be able to facilitate or participate in trades outside the usual trading hours.

3. Speed

ECN trades are usually carried out instantly and at significantly tighter spreads. Since many different providers of liquidity are competing for orders to trade, they are motivated to provide the lowest spreads in order to attract traders and beat the competition.

4. Flat Commission Rate

Rather than making money off the spread, an ECN broker usually charges a flat commission rate.

5. ECN Brokers Don’t Trade Against Their Clients

ECN brokers are the only intermediaries between their traders’ bid and ask orders, matching them up with a wide range of market participants. Therefore, they don’t bet against traders, and never take the other side of their clients’ trading positions.

ECN brokers earn commission whether traders make profits or losses, hence there is no conflict of interest. This trading model provides better trading conditions, increases transparency, and limits price manipulation.

ECN brokers don’t ‘make markets’ by creating their own quotes, and it’s harder for them to manipulate prices because they use prices from various liquidity providers.

Moreover, with ECN brokers, traders have access to current, real-time information and more accurate prices. This makes it even more difficult for brokers to manipulate market prices.

By displaying prices transparently on their platforms, ECN brokers enable their clients to trade faster, with lower spreads compared to other types of brokers. Additionally, traders usually get lower instant confirmations as well as lower commissions and fees.[4]

6. Traders Can Avoid Re-quotes

Re-quotes can impact traders’ overall performance negatively. In most cases, this happens when trading orders are rejected because of the changes in the prices of the assets traders want to invest in. Then, brokers offer traders “re-quotes” for the given assets, which rarely work in traders’ favour.

7. Direct Market Executions

ECN traders usually don’t interfere with your relations with other market players. Therefore, unlike other types of brokers who can record your position and negotiate it with the liquidity provider, ECN brokers allow you to negotiate your trade directly to the market player in the best conditions.

Therefore, when you open a position for, say, USD/EUR pair, you don’t have to wait until the ECN broker takes the position to the provider.

An ECN broker allows you to do that yourself and negotiate with your preferred USD/EUR liquidity provider represented on their trading platform. With no middle man between trading partners, assets tend to be very liquid, and traders can buy or sell currency pairs instantly.

The Bottom-line

Although there are numerous brokerage companies operating world-wide, it is essential to keep in mind that not all are regulated by financial authorities. Therefore, some unregulated brokers may advertise themselves as ECN brokers but could actually be  dealing desk brokers. Therefore, it is essential to ensure that the broker you are dealing with is a regulated ECN broker.

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Reference

  1. “What is ECN Trading and What are its Advantages? – Yahoo Finance.” 28 Feb. 2019, https://www.yahoo.com/now/ecn-trading-advantages-120611422.html. Accessed 8 Apr. 2022.
  2. What is ECN Trading and What are its Advantages? – Yahoo Finance.” 28 Feb. 2019, https://www.yahoo.com/now/ecn-trading-advantages-120611422.html. Accessed 8 Apr. 2022.
  3.  “ECN Broker – Overview, Characteristics, and Advantages.” https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/ecn-broker/. Accessed 8 Apr. 2022.
  4. “ECN Broker – Overview, Characteristics, and Advantages.” https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/ecn-broker/. Accessed 8 Apr. 2022.
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