Electronic Communication Network – ECN

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Introduction to ECN and ECN Brokers

In this installment of our Glossary series, we will explore ECN and ECN Brokers, which play crucial roles in the forex market.

Definition

An Electronic Communication Network (ECN) is an automated computer system that matches buy and sell orders for securities in the market. It connects major brokerage firms and individual traders, allowing them to trade directly with one another without intermediaries like banks. This system enables investors from different geographic locations to trade quickly and easily. The U.S. Securities and Exchange Commission (SEC) requires ECNs to register as broker-dealers.

Role and Function of ECN

Classified by the SEC as an Alternative Trading System (ATS), ECNs earn revenue by charging fees for each transaction to fulfill financial obligations. They aim to eliminate the role of third parties in executing orders entered by market makers on exchanges or OTC market makers. Orders placed through ECNs are typically limit orders. One major drawback of using ECNs is that transaction fees can be expensive, potentially affecting your profits.

ECNs are computer-based systems that display the best available bid-ask prices from multiple market participants and automatically match and execute orders. They facilitate trading on major exchanges during working hours and are also used for after-hours trading and forex trading. ECNs enable dynamic and quick order matching and execution.

Examples of ECN in Practice

Some of the major ECNs include Instinet, SelectNet, and NYSE Arca. Instinet, the first ECN, was established in 1969 and is used by small brokers and for inter-institutional transactions. It is widely used by market makers for NASDAQ trades, but individuals and small businesses can also use it.

SelectNet is primarily used by market makers but does not require immediate order execution and allows investors to trade with specific market makers. NYSE Arca evolved from the merger of the New York Stock Exchange (NYSE) and Archipelago, an ECN founded in early 1996. It facilitates electronic stock trading on major U.S. exchanges such as NYSE and NASDAQ. In the forex market, certain brokers are designated as ECN brokers, who can facilitate currency trading on electronic communication networks.

Understanding ECN is fundamental to grasping the next important concept – ECN Brokers.