Is Your Forex Broker Really an ECN Broker?

ECN Broker

ECN Broker

One of the most popular categories that traders look for when looking for Forex Brokers is the ECN Broker category. The perception here is that this the only way to be absolutely sure that my Broker and my interests are completely aligned is to use an ECN Broker. Most traders arrive at this conclusion without even really understanding what an ECN is.

ECN stands for Electronic Communications Network and is used throughout trading in securities and futures markets. ECNs came into prominence in the late 1990s in the U.S. with a system called Island. Island was an ECN that allowed traders to trade with each other and outside of the traditional NASDAQ market maker. That time on the NASDAQ market most transactions were facilitated by these market makers. Traders were not satisfied with wide spreads and poor execution by many of these market makers and therefore the popularity of the ECN grew rapidly. Using the Island ECN traders knew that they were getting the best trade execution. The way the ECN worked was you could set your limit price no matter what the size of the trade was and this would narrow the spread. If a trader using island was willing to buy or sell at that price then the order was matched.

At the time this was considered to be revolutionary in the trading world and changed the way things were done. It was common practice for NASDAQ market makers to influence and set prices with profit in mind rather than maintaining a fair marketplace. While this was great for traders, one problem did arise from using the Island ECN. This was the problem of partial fills and being stuck with odd lots. An odd lot refers to a trade less than 100 shares and as most traders were trading rapidly and usually trading increments of 500 or 1000 shares this became problematic. The solution eventually came in the form of the Archipelago ECN. This ECN integrated Island ECN with other ECNs as well as Market Maker execution.

Now understanding the complexity of how an ECN worked in the securities world imagine how it would be in the world of Forex Trading. One very distinct difference between Securities and Forex is that the Forex Market has no centralized exchange. When traders were trading on Island and Archipelago the trades were going through NASDAQ and were being reported and recorded. There is no such reporting that happens in Forex. Remember that the trades among Island traders were matched. How could a trade be matched when one trader is with FXCM and another trader is with Gain Capital. These brokers operate completely independent of one another.  Forex Brokers do use aggregation systems like Currenex and Integral. These systems in the way they are mostly used by brokers are not matching but are distributing Bank liquidity. Making claims of being an ECN in Forex should be met with some skepticism and traders should understand what an ECN really is.

 

Trading Forex and Derivatives carries a high level of risk, including the risk of losing substantially more than your initial investment. Also, you do not own or have any rights to the underlying assets. The effect of leverage is that both gains and losses are magnified. You should only trade if you can afford to carry these risks. Trading Derivatives may not be suitable for all investors, so please ensure that you fully understand the risks involved, and seek independent advice if necessary.