What are ECN Forex Brokers?

Posted by Deb | Forex,Guest Post | Tuesday 21 August 2012 1:31 am

The concept of ECN forex trading has become widely popular during the last few years. Most of the brokers advertise they are ECN, but are they really? And what exactly means ECN? I will try to answer these questions and explain the nature of ECN trading in Forex in the next lines.

After you read this article please tell me if it was useful to you and how it contributed to your trading experience.

There is a wide range of ECN forex brokers offering a variety of trading instruments. By definition ECN means electronic communication network. To understand the nature of ECN execution I will have to briefly explain the main models of execution: Market Maker, ECN and STP.

ECN Forex Brokers

Market Makers

The market makers are usually large institutions and banks who literally make the market by taking the risk against its counterparties. Say, a major US bank want to purchase few millions of dollars from a EU bank will create risk for both the counterparties if the EUR/USD rate goes in a certain direction. The EU bank will play the role of Market Maker because it takes the risk against its counterparty. Although, you will find similar definitions of “market making” over the Internet, small forex brokers can also be market maker for their retail clients. Instead of two large banks, let’s now have two counterparties – the small forex broker and its clients. Suppose today 100 clients bought and sold different quantities of EUR/USD. The broker will simply combine all of that and net the overall client position. After that it will receive for example long 15 million against its clients. Now the broker can decide whether and how to hedge its exposure against the clients. It might be also taking the entire risk in EUR/USD if it has already hedged exposure in another instrument which is highly correlated with EUR/USD. In this sense we can say that everybody is market maker, even each individual client because each of us takes the risk against its counterparty.

STP

STP stands for straight through processing and in means direct transfer of each order to other counterparty. If a forex broker claims that it is STP, each of your orders should be routed to another counterparty which acts as a liquidity provider to the STP broker. In this case the broker and you do not have a conflict of interest arisen from the opposite direction of your positions. However, I might argue that because the broker interest is you to execute the trade regardless of whether it will win or lose. Somehow, this constitutes a conflict of interest because the broker has the opportunity to generate profit from spreads and commissions without caring what your result is.

ECN

ECN trading almost mimics the stock exchange trading style. It offers you a trading book with all the best orders listed from both the buy and sell side. In this case all the counterparties compete to provide the best price for the quantity they offer. Thus the spread is formed by making the difference between the best bid and ask offers and sometimes is narrowed down to 0.4-0.3 pips. Of course, commissions apply for this type of execution and the real price of a trade would be 0.7-0.8 pips. As with STP, the ECN trading does not imply a direct conflict of interest between you and your broker, however slippage and re-quotes might occur due to the fact that your broker gets it from its counterparties.

Is the ECN model the best?

It might be said that pretty much ECN would be the most transparent model of all. However, there are pros and cons for each model. For example a large liquidity provider – market maker might provide absolutely sharp execution due to its high volumes available in its client pool. However, the trading costs might be quite high due to the fact that fixed or variable spread is paid each time regardless of the current liquidity.

All in all there is not a best model but rather a best broker for your trading style. If you find a good broker with instant and fair execution you might not care what is the trading model applied.

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3 Comments »

  1. Comment by Invest With Forex — March 14, 2013 @ 3:43 pm

    I think ECN brokers are forex brokerage firm that provide it’s clients direct access to the other forex market participants.
    Invest With Forex recently posted..Broker Pricing: Getting the Best Price for Your Trades

  2. Comment by Oscar from ECN Forex brokers — May 16, 2013 @ 7:34 pm

    ECN Forex brokers can offers spreads as low as 0 pips too. In this case, they earn all their money from the commission. I’ve seen some competitive commissions out there under $3 / lot. It’s worth shopping around and comparing brokers because the numbers all add up eventually.

  3. Comment by Joey from forex affiliates program — August 23, 2013 @ 11:38 pm

    An electronic communication network (ECN) is a financial term for a type of computer system that facilitates trading of financial products outside of stock exchanges. The primary products that are traded on ECNs are stocks and currencies. The first ECN, Instinet, was created in 1969. ECNs increase competition among trading firms by lowering transaction costs, giving clients full access to their order books, and offering order matching outside of traditional exchange hours. ECNs are sometimes also referred to as Alternative Trading Systems or Alternative Trading Networks.
    Joey@forex affiliates program recently posted..Forex-Metal Offers Free Forex VPS for Active Traders

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