Trade execution usually doesn’t rank that high for most traders, especially in the retail forex business. That being said, the past few years has brought about some market volatility which has no doubt increased trader’s curiosity about how their trades are executed by their forex broker.
The most notable event which made an impact was last year’s (2015) Swiss Franc de-peg which saw quite a few retail traders either swallowing huge losses or making the biggest wins in a day. It also brought down quite a few forex brokerages including a few reputable ones as well. The Swiss Franc event in 2015 thus set forward period of awareness among traders as to how their trades are executed by their forex brokerages and, of course, brought the spotlight on whether it is best to trade with a market maker or an ECN/STP forex broker.
But what exactly is an ECN forex broker? In this article, we explain in detail what an ECN is and how your trades are executed by the broker.
ECN Forex Trading – The Network
ECN is an acronym for Electronic Communications Network. It is not to be mistaken with some kind of an intranet/extranet but merely a protocol that is adopted by forex brokerages are their liquidity partners for executing trades. ECN brokers primarily act as ‘Middle Men‘ (and thus the named broker) between the liquidity partners made up of banks and large institutions and the retail/trading community. The trades placed by the trades are routed directly and matched with the liquidity providers and when there is a matching order, the trade is executed. Of course, all of this happens in real time and hardly noticeable.
With an ECN forex broker, traders should know that the other side of their trade (also known as a counterparty) is made up of either one or a pool of institutional orders. The broker does not get involved as a counterparty but merely passes on their retail customer’s orders. Of course, the ECN broker does this for a small fee. This fee could either be in the form of charging a commission per trade or by adding a markup to the orders by a few pips.
ECN Forex Trading Vs. Market Making
As you might have understood by now, ECN forex trading is perhaps one of the simplest ways to do business as a forex broker. Unlike a market making a model where client’s trades are always accepted in-house which opens up the question on ‘conflict of interest’ between the brokerage and their customer. When the customer losses, the brokerage wins and vice versa (although this is not always the case as orders can also be routed differently with a market maker).
However, the point to understand here is the fact that with a market maker, there is a higher chance that your orders will be filled at the price you want to bid or ask at. This changes when it comes to an ECN forex broker where the order execution depends on whether the counterparty wants to accept your bid or ask at the price level you quoted. In other words, while an ECN forex broker can offer fast executions if the counterparty does not match your bids or asking prices, chances are that your orders remain unfilled.
And this was something which happened last year during the SNB event where, when the Swiss National Bank gave up the 1.20EURCHF floor, there were no orders below 1.20 leaving a large void and thus traders ended up with trades, where they were unable to defend it with stop loss orders. On the other hand, market makers managed to fare better given the fact that the order routing was different.
ECN Forex Trading – Is it good or bad?
There is no right answer to this question and more importantly, the answer can vary from one trader to another. The fact remains however that for traders who prefer to trade big and quick, an ECN forex broker can be the best match as commissions or spreads can be lowered especially if you bring big volume to your broker. On the other hand, traders who merely trade part time and are not very aware of the market risks are better off trading with a market maker instead.