How ECN brokers work?
Basically, ECN brokers (Electronic Communication Network) are companies that offer their customers the best prices to trade in the market since they are in direct contact with many market participants such as banks, Market Makers and other traders that are connected and trading in the same electronic interbank network. In this way, the ECN brokers are able to offer the best bid and ask quotes in their trading platforms based on those prices.
In general, the ECN brokers also can serve as counterpart in the Forex market trading, with the difference that they operate based on an agreement with the client rather than based on the price as occur with the Market Makers. Also, these brokers offer variable spreads, whose value depends on the currency pair that the speculator is trading and the conditions prevailing in the market at any given time. For example, during periods when the market is very active, sometimes the spread may be even zero, particularly in the most liquid currency pairs like EUR/USD, USD/JPY, GBP/USD and USD/CHF, the major Forex currency pairs.
Unlike the Market Makers, ECN brokers make their money charging a flat fee for every transaction made by their clients. The authentic ECN brokers play no role in the creation or establishment of prices, therefore, the risks of price manipulation are reduced for customers who trade with them.
Similar to the Market Makers, there are two main types of ECN:
- Retail ECN: This type of ECN offers its customers quotes from a few banks and other traders who act as the counterpart for the transactions.
- Institutional ECN: On the other hand, these ECN offer the best bid/ask prices from multiple liquidity providers, including institutional Market Makers such as banks to other banks and institutions of various kinds, like large corporations and hedge funds.
Benefits of ECN brokers
- The trader can usually obtain better bid/ask prices as these are derived from multiple sources.
- These companies offer the possibility to trade with prices that at certain times have a extremely low spread, that even can be equal to zero.
- The genuine ECN brokers do not trade against the trader because they simply pass orders to a bank or another client on the opposite side of the transaction (to serve as counterpart to the transaction). This means that if the customer buys, the ECN broker searches for a seller and if the client sells, it search for a buyer to complete the transaction. In this case, the broker is not directly involved in the operation by which conflicts of interest do not occur as with other brokers.
- Prices may be more volatile, which may be better to implement trading strategies based on scalping.
- Since the trader is able to offer a price between the bid and ask, he or she can assume the role of Market Maker to other traders who are trading in the ECN.
Disadvantages of ECN brokers
- Many of these brokers do not offer a good trading platform with analysis tools such as advanced graphics and an adecuate integrated news service about the market.
- In general, the trading platform tends to be less user friendly than the plataforms offered by other brokers.
- Because of variable spreads between bid and ask prices, may be more complicated to calculate stop loss and break even points (the price at which if the position is closed it produced no gain or loss, ie an equilibrium point) in terms of pips in advance.
- Traders must pay fees for transactions, which constitutes the main means by which these brokers make profits.
Difference between ECN and retail brokers
A retail broker is a company that acts as a Market Maker in all customer transactions. In many cases these companies trade against the trader, hide prices and carry larger spreads in their prices arbitrarily. Because the retail broker trade against the client, conflicts of interest often occur between the trader and the broker, which may cause the broker to manipulate the trade, so at the end the client lose money in that trade and the broker ends up winning it. Some of these brokers usually perform this manipulation especially if the trade have a high gain/ loss potential.
Among the advantages of retail brokers, can be mentioned that these companies allow to open a trading account with little money, and often have a fairly high leverage. The customer has the option to open a demo account in which is possible to trade with virtual money using the trading platform normally offered by the company. Through this demo account, the trader can learn to trade in the market and practice their trading strategies before risking money in the process. Most of these brokers allow to trade with microlots (0.01 lots) and minilots (0.1 lots), so these companies could be a good option for begineers traders with less capital to invest than professional traders.
An ECN is an interbank broker. A real ECN never works against the trader therefore do not need to manipulate the price. These companies consolidate the banking prices and provide the trader with the best prices available on both the bid and the ask. This allows to trade with very low spreads as mentioned above, however, the trader must pay commissions for each trade. When a trader sends an order to make a transaction, the ECN passes this order directly through the interbank system to find a counterpart for the transaction, which in this case is usually a real trader. Normally, the leverage offered by these brokers is lower than the leverage offered by retail brokers and the minimum amount for opening a trading account is usually higher.
The trades in the interbank system are made in increments of 100000 units (1 lot), so in some of these brokers, the trader must have sufficient funds to cover $7 – $10 per pip on each transaction, which must be very taken into account when the trader is designing the strategy for money managment.
ECN brokers and Daytrading
Undoubtedly for daytrading, ECN brokers are the best option because for retail brokers is much easier to manipulate prices in the short term. Also, most of the ECN brokers allow to trade between the bid and the ask, which allows the trader to use trading strategies based in scalping (trades at very short term, these are trades that can last from a few seconds to several minutes), as originally made the floor traders.
ECN brokers list
The following is a list with some ECN brokers that allow to trade in the Forex market and with other financial instruments. In most cases, these brokers offer their clients trading accounts with ECN execution and Dealing Desk execution (Market Maker) so the trader can select the option that is most appropriate.