What is Electronic Communication Network (ECN)?
ECN is a computer system that buys and sells orders for securities. It is an automated electronic system which takes up the role of a third party when it comes to execution of orders. This system is designed to allow trade orders entered by a market maker to execute either partially or entirely.
The introduction of ECN eliminated the need for middlemen between traders and brokerages. This is attributed to the ability of the ECN to connect brokerage firms with individual traders. Furthermore, it opened up direct trade without the need of a go-between agent.
In the US, ECNs need to be registered as broker-dealers. They are classified as alternative trading systems which mean they make money by charging a fee for every transaction. Fees are classified as classic and credit.
Classic structures have been found to attract liquidity owners while credit structures attract liquidity providers. This is done to meet financial obligations of the system. One thing you need to know is that orders executed via an ECN are limit orders.
As an alternative trading system, it aids with facilitating the trading of financial products like currencies and stocks. Additional features available with the system include negotiation, pegging and reserve size. Examples of ECNs include Instinet, SelectNet and NYSE Arca.
How it works
It is important to note that ECNs display orders in the consolidated quote stream. SEC requires the registration of ECNs as broker dealers and as members of FINRA. Placing an order with the electronic communication network is quite simple.
First and foremost, you need to be an ECN subscriber. Only broker -dealers and select institutional traders are meant to be subscribers to the ECN. Individual traders must have an account with a broker-dealer subscriber who in turn places the order via the ECN. Remember, the ECN is designed to eliminate the need for middlemen.
A trade execution occurs only when buy order and sell order prices intersect. Majority of individual traders believe that they have a direct connection with the markets. Sadly, this is not true. The only connection individual traders have is with the broker. Only the brokers decide where to send a trade for execution.
Advantages of the Electronic Communication Network
1. Ensures automated trading
ECN’s are developed with intelligent APIs which allow trades to be automated. This enables broker-dealers to connect different trading models with the network’s data match engine. As a result, clients have access to data feed. This has been found to promote trading efficiency and live trading too.
2. Allows trading between bank and client
Commercial banks around the world have taken up the role of broker-dealer. They allow clients (individual traders) to open accounts with them and trade. What you need to know as a trader is that it’s difficult to pursue real time trading with banks. Only ECN can do this.
3. Keeps your trading activities anonymous
The good thing about ECN’s is that they assure you of anonymity. This is done with the purpose of preventing biased dealings. Furthermore, it helps to provide a fair platform for traders to engage with actual market conditions.
4. After hours trading
After hours trading allows the buying and selling of securities on major exchanges after the market is closed. AHT’s provides investors with the ability of experiencing higher gains but the problem is there are inherent risks and dangers. They include less liquidity, wide spreads and volatility.
Final Thoughts
Electronic communication networks are praised for having ushered in a new era of trading. Not only did the system result in the implementation of protocols but it eliminated the need for intermediary brokers.
This has enabled individual traders to come together and make direct orders regardless of their geographic location. Some of the benefits provided by ECN’s include anonymity, lower transaction fees, after hours trading, access to market prices, full access to order books and regulation by the SEC.