It’s only when you cast your mind back to the early 1990s that you begin to understand just how much forex trading has changed throughout the years, with technological advancement and innovation have played a key role in this evolution.
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Of course, such innovation has also introduced new investment vehicles and methods of trading, with ECN (electronic communication network) trading offering a relevant case in point.
But what is ECN trading, and how does it differ from standard accounts and methodologies? Let’s find out.
What is ECN Trading?
In simple terms, an electronic communication network is a computerised system that automatically matches buy and sell orders for various securities in the market.
Typically, this type of trading is helpful in certain geographical regions where investors want to complete secure transactions without the use of a third party, but we’ll touch a little further on the benefits of ECN trading a little later in the piece.
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Categorised as a pure order-matching execution system, in which the account provider charges a premium as commission per trade rather than simply artificially inflating the raw spread which occurs naturally as part of the matching process.
OK, we hear you ask, but how does an ECN trade differ from standard trading accounts? Well, the key difference is the core functionality, as while an ECN account will automatically match and execute orders in exchange for a simple commission, whereas standard accounts will be managed by a market-making broker that utilises premiums to profit from execution.
This translates into far greater transparency and cost-effective trading for investors, so it’s easy to see why ECN trading is so popular.
What are the Pros and Cons of ENC Trading?
As we’ve already touched on, ECN traders can rely on more transparent and affordable commission fees, enabling them to operate more comfortably and boost their final profitability.
Another benefit of ECN trading is the presence of tighter bid-ask spreads, which also translate into considerably low trading costs over time. On a similar note, ECNs are also faster and more private than third-party transactions, which also creates more efficient and profitable execution over time.
You should also note that ECNs are open when stock changes are closed, affording investors additional trading hours and more opportunities to pursue viable profits.
However, there are some drawbacks to using an ECN, including the increased risk of market fragmentation.
Because ECNs match buyers and sellers within their systems, there is a much higher risk of insular trading that can cause associated prices to deviate from those within the broader marketplace.
Of course, this can usually be resolved through arbitrage trading (when traders simultaneously buy and sell the same security in two different markets), but may still cause short-term disruption and fragmentation.