Over the course of the 21st century, the way that we have begun to trade has been revolutionised, with technology very much taking a centre stage. Unlike in Hollywood tales, where stock markets are king and people only trade using various papers, much of the trading we now do is online, with millions of people across the globe trading from their computer at home, at work, or through their mobile on the go. IT systems have been central to this revolution in trading, with the option to trade filtering out to millions of hard working people rather than just an elite few who can afford the losses. Some would argue that ECNs have been the most important part of this move, but what are they, and what do they do?
What is an ECN?
ECN stands for Electronic Communication Network. An ECN is an automated system that matches buy and sell orders for securities. Each ECN will charge a small amount per transaction. However, for investors, this is a very small price to pay, with ECNs providing them with the possibility to trade with investors anywhere in the world in a matter of seconds. As you would expect, because of their nature, they have to be registered and regulated.
What exactly do they do?
In order to complete transactions, an ECN will create a complex series of connections between a number of institutions (banks, businesses etc.) and individual investors. This means that the two can trade between themselves, thus eliminating the need for a ‘middleman’ and tightening spreads.
An ECN can completely eliminate the role of a third party in the transaction. Orders placed through ECNs are usually (but not always) limit orders, with the ECN permitting these orders to be either partially or entirely executed.
To aid the investor, an ECN will scour the market before displaying the best available bid and ask quote. To do this, it manually searches for quotes from multiple market participants, before matching the order and executing it on behalf of the client. Although, due to this function, they are predominantly used during market hours to find quotes from major exchanges, they are also used after markets are closed, and there are also specialist forex ECNs.
Specific trader benefits
When you’re trading, finding a market that will move in the right direction for you is hard enough so, when you find one, you want the best possible deal and the tightest spread. Because ECNs directly integrate with liquidity providers, these then compete anonymously for your business, ensuring that you get the very best offer available.
As a direct result of this, overall benefits include but are not exclusive to:
- Very tight spreads
- Improved execution rates
- Accurate ticker data
- Deep liquidity
- Minimal (if any) slippage
Due to all this, it is very easy to see how ECNs have improved trading immeasurably, opening the whole process up to a much wider target audience. With this becoming commonplace in the last decade, it will be interesting to see what IT developments revolutionise the way we trade in the decade to come.