Trading without middlemen
When people get into trading, they need various companies that provide assets for trading. Such companies are called liquidity providers and they are the ones that make trading possible.
However, in many cases, traders and liquidity providers don’t interact with each other directly. Instead, there are middlemen who connect the two parties and bring them in a single working space.
Those middlemen are called STP (Straight Through Processing) brokers. STP brokers provide almost everything needed for trading, apart from trading assets that are provided by liquidity providers. But more importantly, instead of traders, STP brokers negotiate trading positions with liquidity providers.
ECN meaning explained
While STP brokers are more common in Forex, it doesn’t mean that traders cannot communicate with liquidity providers directly. If they want to have a direct connection with them, they can certainly choose ECN brokers who will connect them without interference.
ECN stands for Electronic Communication Network and brokers that use it offer uninterrupted communication between traders and liquidity providers. And when they connect one side to another, they don’t interfere in their negotiations and agreements.
ECN brokers act as some sort of hub for various liquidity providers, be it major commercial banks, funds, or others. Those various providers come together in a single platform where all their price quotes (offerings) are represented and offered to traders.
Advantages of ECN trading
There are various advantages associated with ECN trading and direct connection with liquidity providers. Here are some of them:
- Higher bid and lower ask prices
- Tighter spreads
- Direct trading and better liquidity
- Immediate trade executions
- Brokers cannot trade against their clients
Let’s take a look at each of those benefits briefly.
ECN markets offer tighter bid-ask spreads
As we mentioned earlier, ECN brokers act as hubs for various market players operating in Forex. Those players can be commercial banks,
hedge (investment) funds, or others. This also means that ECN brokers aggregate all the bid and ask price quotes from those players.
And since there are many players in one place, it is inevitable that there will be both higher and lower bid/ask prices quoted in this “hub”. On the one hand, there will be liquidity providers who have lower bid prices and higher ask prices, resulting in larger spreads.
But on the other hand, there definitely be those who have higher bid and lower ask prices, which results in tighter spreads. What’s more, traders can buy currency pairs from one liquidity provider at a lower price and sell them to another for a higher price. That is the convenience that ECN networks offer.
Direct market executions
Another very important and beneficial aspect with ECN brokers is that they don’t interfere with the relations between traders and market players. This means that unlike STP brokers, who record traders’ positions and negotiate them to liquidity providers themselves, ECN traders can negotiate their trades directly to the market players in the most suitable conditions.
This means that when a trader opens a position for, say, EUR/USD pair for one lot, they won’t need to wait until their broker takes that position to the liquidity provider and negotiate it with them. Instead of that, they can do that themselves and negotiate with the most suitable EUR/USD provider represented on the platform.
For this reason, assets are also very liquid because there are no middlemen between the trading partners. What this means is that currency pairs can be bought or sold without too much delay, right between a trader and its partnering liquidity provider.
ECN account vs standard - trading against clients
This next factor is associated with trading against the clients’ positions. There are many cases where STP brokers open exactly the opposite positions of those placed by their clients. For instance, when a trader opens a long (buy) EUR/USD position, and when a broker delivers that position to the liquidity provider, it will also open a position which will be exactly the opposite - short EUR/USD for the same size.
Many STP brokers trade against their clients because they can get larger payouts from this practice. For instance, if a trader loses from the above-mentioned trade, a broker will gain a payout, but if a trade is successful, the broker will lose its funds.
But as we have already mentioned, ECN networks are not created to transmit traders’ positions to the liquidity providers. Instead, traders do that themselves. And for that reason, brokers cannot go against their clients’ positions.
Disadvantages of ECN markets
Trading Forex with ECN brokers is beneficial for the reasons we have listed above. But it doesn’t mean that they have no downsides. For high service prices, commissions, and other aspects, many traders will decide not to choose ECN brokers. So, here are those disadvantages explained briefly:
- High deposit requirements: since ECN brokers offer direct communications between traders and liquidity providers, they have high service prices as well. That’s why they usually demand larger initial deposits to open the account;
- No micro-lots: this one is connected with high service costs and requirements from liquidity providers. Those market players that are represented in this platform often have a minimum position size of 0.1 lot (10,000 currency units). Therefore, traders cannot open positions for 0.01 lot (1,000 currency units);
- Fixed commissions: since ECN brokers tend not to take spreads for service payment, they have fixed commissions and fees for each transaction. And usually, those commissions are considerably large, proving once more that while FX ECN market share is not that large, expenses are still quite high.
There are, of course, other disadvantages with ECN brokers. For instance, the platform is really complicated to use and traders have a hard time understanding all the terms and tools needed for this type of trading.
Therefore, it’s all about deciding whether the services offered by ECN brokers are worth high expenses. For instance, if you want to open large positions and have tighter spreads, then the Electronic Communication Network might be a better option for you. But if your budget is somewhat modest and cannot open large positions, then STP brokers may offer better conditions for your needs.