Those who enter the forex market have to consider a lot of aspects before getting started with trading. Since the currency market is truly transparent and decentralised, the execution of trades is dependent on brokerages that connect us to the market for trading. We rely on a forex broker for providing real-time price quotes along with a trading platform and trading tools that make the trading process easier. Tools like trading calculators that provide precise results are somewhat essential for making informed trading decisions. But one thing that many traders don’t pay enough attention to while choosing a broker is the way in which the trades get executed.
However, the execution mode of trades is an important factor to consider before signing up. Brokers providing ECN execution have become a popular choice among forex traders but what is ECN trading in the forex market? And what benefits does it offer to traders? You will get to know everything about this topic by the end of this article.
How Forex Brokers Make Money?
To understand ECN, we need to understand how forex brokers make money while serving clients. They function as an intermediary between retail traders and the currency market and make profits by charging spreads and commissions for the trades that are executed through their platforms. The execution mode of trades will vary based on the liquidity arrangements of brokerages. Liquidity is essential to execute any order in the forex market and the trading conditions are also impacted by liquidity.
There are two types of brokers in the forex market: market maker brokers and ECN brokers.
Just as the name implies, market maker brokers are in power to control the market as they set their own prices and act as a counterparty for the trades of their clients to fulfil the orders that are placed on their platform. Market maker brokers are also known as Dealing Desk brokers and they act as liquidity providers.
Drawbacks of Market Maker Brokers
The problem with market maker brokers is that the prices you get will be decided by the broker itself which means the prices can be manipulated by the broker. The bid and ask price of currency pairs will be different from the real-time market prices as the broker will charge you more for making profits in the form of spreads. When you sell a currency pair, the market maker broker becomes the buyer and when you try to buy a pair, the broker will be the one acting as seller. Hence, your orders will always go through the broker and there is less transparency when it comes to the pricing and trading costs.
Because of this, the trading conditions can be less favourable at times but since there is tough competition among online brokerages market maker brokers are trying their best to attract clients by minimising the costs with tight spreads. However, the risk of being financially exploited is always there if the brokerage you choose for trading is less fair in the dealings and takes advantage of their clients being unaware of the hidden costs. But we cannot generalise this as there are quite a few market-maker brokers who have won the trust of their clients by offering competitive trading conditions and seamless order execution.
What is ECN?
ECN stands for Electronic Communication Network and ECN forex brokers execute the orders through an ECN system which ensures No dealing desk intervention during order execution. ECN brokers operate differently from market-maker brokers. They don’t take part in the trading process as they are not acting as counterparties like how market maker brokers do. ECN brokers simply reach out to top-tier liquidity providers like banks and financial institutions and team up with the interbank network to offer real-time price quotes to their clients.
ECN Brokers are not directly involved in fixing the bid and ask prices as the price quotes get determined on the basis of real-time market conditions and the order processing is smooth and fast which results in the reduction of trading costs in the form of spreads and commission. The prices you see on ECN brokerage platforms are more transparent and the risk of price manipulation is eliminated with the brokers only functioning as a connecting link to the deep liquidity pools.
Benefits of trading with ECN brokers
- Better price Quotes
One major reason behind many traders choosing ECN brokers is the fact that they often offer better price quotes which is essential for getting favourable trading conditions. Real-time pricing with raw spreads and fast order execution gives you an edge in the fast-paced forex market. This allows you to optimise your profit potential as less slippage and price re-quotes are happening. You can calculate the potential profit of a trade using a forex profit calculator to understand the impact of different prices on your trading results.
- Enhanced liquidity
ECN brokers are not concerned with the profits of their clients as they always get a commission regardless of your trading results. On the other hand market makers will be directly involved in the trade execution by acting as counterparties while also functioning as liquidity providers. But ECN brokers are not responsible for liquidity but give you enhanced liquidity by partnering with multiple liquidity providers and this ensures seamless execution of trades without any dealing desk intervention. They have access to deep liquidity pools and this is very beneficial for traders.
- Transparency in trading costs
With ECN brokers, you will always find a lot of transparency when it comes to trading costs. They mostly offer variable spreads and fixed commissions which allows you to calculate the total trading cost with precision as there are no hidden costs involved. They also provide low commissions, which is especially favourable for scalpers and day traders who execute multiple trades daily.
With the floating spreads, you will get the advantage of major trading sessions and session overlaps as the spreads will be lowest during active market hours. Spreads are always stated in pips and you can use a pip calculator to determine the monetary value of pips while planning your trades.
- Immediate execution at market prices
Since there is no dealing desk intervention, the order execution is automated and as a result, there are no price re-quotes happening and you will always get the trades placed at the most favourable prices. The orders are set for immediate execution at real-time market prices without any deviation. The fast order execution and instant confirmation make you feel at ease as a retail trader.
- Guaranteed Anonymity of Trading
Another benefit that you get by trading with ECN brokers is the guaranteed anonymity of trading. This is especially essential for those who engage in high-volume trading. The anonymity is advantageous to traders as they always get real-time market prices without any manipulation. Hence, traders who look for anonymity in trading activities have a preference for ECN brokers.
Choice of Accounts
With different brokers, you will also get different types of trading accounts to choose from. ECN brokers may offer raw spread accounts which allows you to take advantage of tight spreads combined with low commission. The trading account offered by market maker brokers will be different. They may offer commission-free accounts by adding a markup to the spreads. Choosing the right type of account is important for getting solid trading conditions that suit your trading style and preferences. You will get quite a few options to consider and comparing the costs will be ideal for making a wise choice.
How ECN Trading Works?
ECN trading works by matching the orders placed by different market participants which include top-tier banks or institutions functioning as liquidity providers and ordinary retail traders like us. The liquidity providers will be entering their orders into the ECN system which allows ECN brokers to offer real-time prices to their clients and then when we place orders, they are immediately executed at the available market prices. The liquidity provider will be on the other side receiving the orders and the spreads will be decided by them instead of the broker. Brokers strive to offer the best prices to their clients by comparing the quotes of different liquidity providers and displaying the most attractive ones.
What’s the catch?
Trading with ECN brokers has many advantages including transparency, anonymity and cost effectiveness. However, the commission charged on trades can result in long-term costs based on the number of trades and the volume of trades executed. But you need to keep in mind that slippages and price re-quotes are possible with any type of broker when insufficient liquidity or high volatility is making it hard to find matching orders in time. In conclusion, ECN trading can be beneficial for those who are keen to minimise the cost of trading with raw spreads and trade without any dealing desk intervention.
