Comparing ECNs with Market Makers - Part 2

[RichardCox 10]

The Common Workings of ECNs

 

ECNs provide traders with some variations from the Market Maker model in that prices are passed through multiple market sources (banks, Market Makers and other participants connected to the framework of the ECN). Since competition is heightened, ECNs are able to display preferable spread (bid/ask) quotes in the trading platforms of their clients. Additionally, ECN brokers are able to act as counterparties in forex transactions - but it should be remembered that ECNs do not operate on a pricing basis (instead, operating on a settlement basis).

 

While some Market Makers are able to offer fixed spreads, ECNs tend to offer variable spreads which are more reflective of the individual trading activity of each currency pair. When market volumes are at full strength, there will be instances where ECNs will have no spread at all. When this does occur, it tends to be seen in currency pairs with the highest liquidity levels (such as the EUR/USD, GBP/USD, USD/JPY, USD/CHF), essentially the majors and some of the crosses.

 

Money is made in Electronic Networks when customers are charged a fixed commission and authentic ECNs play no role in the way prices are made or settled, so there is less of a chance that retail traders will be the victim of price manipulation.

One of the similarities between Market Makers and ECNs is that they can be divided into two categories - Institutional ECNs and Retail ECNs. Institutional ECNs attempt to offer the lowest bid/ask spreads by selecting the best prices available from banks, financial institutions (such as large corporations or hedge funds) and other Market Makers. Conversely, retail ECNs will offer currency quotes to retail traders from a selection of banks or other active traders available on the ECN.

 

Benefits of Trading with ECNs

 

When looking at the benefits of ECNs, examples can be seen in the preferable bid/ask prices that are generally on offer. This occurs because ECNs draw from several sources, which essentially forces additional competition as each source works against the others to provide the best prices. These factors make it possible, in some cases, to capitalize on little or no spread charges, which can help give a small boost to your overall profit and loss ratios.

 

Authentic ECN brokers do not trade against their client traders, because orders are passed on to banks or other institutions which take the opposing side of each trade. With all of these factors, traders will often encounter increased volatility in price activity (which might be viewed as beneficial for traders implementing scalping strategies). In addition to this, it is actually possible to play the role of Market Maker relative to other traders on the ECN, because there is the potential to offer a price for a currency that is somewhere in between the bid and ask values.

 

Drawbacks of Trading with ECNs

 

When looking at the drawbacks of ECNs, most of the negatives can be seen in the fact that many ECNs do not provide integrated newsfeeds or charting packages for their clients. Because of this, traders will need to use multiple trading sources in order to conduct additional methods of analysis. This applies to traders using both technical and fundamental strategies, and many of the trading platforms that are offered by ECNs are not as user-friendly as some of their counterparts.

There is the added negative that it can be more difficult to manage active trades (calculating stop loss and breakeven levels), given the variable spreads that can fluctuate and separate the bid and ask prices in each currency pair. Last, there is the added commission factor, as this is a per-transaction charge that is not given to traders using other market options.

 

Conclusion

 

Forex traders should pay special attention to the type of broker that is used to gain access to the broader market. The decision to select one option over another can have a significant impact on your ability to maintain a solid trading performance. When trades are not executed in a fast and efficient manner (and at your chosen price), it can become increasingly difficult to capitalize on profitable trading opportunities as they develop. Worst case scenario, profitable trading opportunities can turn into losses, so forex traders should be careful to weigh all of their options and determine the differences between the potential pros and cons in each broker type.