The quick definition is that ECN (Electronic Communication Network) brokers allow traders to place competing bids against each other. They are NDD (No Dealing Desk) brokers, which means that instead of passing orders to market makers who take the opposite position of a trade, they directly connect buyers and sellers. When they cannot match two counterparties, they offer the highest bid price and the lowest ask price on the open market.
ECN forex brokers are a major source of liquidity for retail traders compared to major market makers such as large banks, hedge funds and other financial institutions. Globally, they're the fastest growing brokers and they're particularly popular for currency trading as they offer greater transparency to investors.
ECN brokers are very similar to STP (Straight Through Processing) brokers. Neither of them have a dealing desk. Listed trades are routed to the broker's group of liquidity providers, such as hedge funds, major banks and investors. These providers act as counterparties for each transaction and compete with each other to obtain the best spreads between supply and demand. The broker effectively acts as a silent facilitator, connecting the trader to their internal liquidity pool while taking a small commission via a spread increase.
The main difference between ECN and STP brokers is routing. While the STP broker provides access to different providers in its liquidity pool, the ECN broker acts as a hub. The hub essentially acts as the primary source of liquidity, made up of the various hedge funds, banks and market participants. The other notable difference is the size of the positions. ECN brokers generally cap the minimum position size at 0.1 lot. This is because few liquidity providers are able to support smaller position sizes, which can be difficult for beginners.
Both the ECN and STP models offer fast trade executions and tight spreads that lend themselves to a range of strategies such as scalping. In fact, many ECN, STP and hybrid brokers offer zero-pip forex spreads, although they may charge a fixed commission per lot.
Trading via an ECN has several advantages:
The following are the drawbacks of trading with an ECN broker:
ECN brokers offer many benefits to currency traders. High levels of market transparency mean price manipulation is not possible. However, you should still look for regulated ECN brokers. Leverage levels, commissions and trading tools are also key to consider when opening a live account with an ECN broker.
An ECN broker is a technology hub, or a bridge, that allows traders to place competing bids with each other or with liquidity providers.
ECN brokers generally make money from fixed commissions they charge you for each trade. This is in contrast to market maker models which typically make their money from the spread.
Market makers ensure that there's enough liquidity so that trades can be executed without problems. Market makers usually take the opposite side of a trade. In contrast, ECN brokers connect buyers and sellers, using different liquidity providers. ECN brokers generally offer tighter spreads, faster order execution and increased transparency.