The global foreign exchange market accounts for more than $5 trillion in daily turnover. Banks, hedge funds and institutional investors account for a majority of this value, but when it comes to individual transactions, retail traders are the majority. Most of them invest anywhere between $5,000 and $10,000, which makes it a little difficult to sign up with a mainstream true Electronic Communications Network (ECN) broker.
ECN forex brokers require traders to invest huge sums to be allowed to trade with them. As such, many retail traders end up in the hands of market makers, also known as dealing desk brokers.
Dealing desk brokers provide liquidity to their clients by taking the opposite side of the trade after a client opens a position. This can create a conflict of interest, thereby leading to transaction manipulation by some unscrupulous brokers. As such, most traders prefer to deal with non-dealing desk brokers, which in this case, are composed of ECN brokers and Straight Through Processing (STP) brokers.
The main difference between STP and ECN brokers is that ECN brokers provide liquidity to their clients by giving them access to other market participants which include banks, hedge funds, and institutional traders whereas STPs provide liquidity to clients by linking client transactions directly to liquidity providers.
The benefits of using a true ECN forex broker
There is a great deal of positivity surrounding ECN forex brokers when compared with dealing desk brokers. This positivity is brought about by the numerous benefits that traders enjoy when using an ECN forex broker. Here are a few that stand out.
Anonymous trading and neutral pricing
Since ECN forex trading is anonymous, it allows traders to take advantage of neutral pricing. This ensures that actual market conditions are reflected in all trading activity. As such, there cannot be bias against a client’s trading strategies or open positions. Traders also benefit from multiple technical efficiencies including fast trade execution speeds and tight spreads as discussed in-depth in this piece by engine forex.
Access to market participants and liquidity
When trading with an ECN broker, traders have access to other market participants, which include the big players like institutional investors. As such, clients have an opportunity to trade with a global liquidity pool of qualified, regulated and highly competitive financial institutions. This ensures that the execution of the order price is virtually guaranteed.
Traders can scalp their way to success
Because ECN brokers make money from the standard commissions they charge and the size of deal flow rather than winning or losing trades of clients, they allow traders to use all strategies including scalping. And because execution speeds are high when trading with ECN forex brokers, traders find it easier to use forex Expert Advisers (EAs) thereby applying their automated trading strategies.
Risks of trading with a true ECN forex broker
These can vary depending on different client profiles. But they mostly affect small retail traders. Here are a few that any trader looking to use an ECN forex broker should bear in mind.
The risk of variable spreads
Since ECN forex brokers use variable spreads that are dictated by the prevailing market conditions, at times these spreads can shift dramatically especially when there is slippage in the forex market, which can affect a client’s trading strategy. When the market is exhibiting high volatility, spreads can widen significantly thereby affecting open positions.
The cost of trading with an ECN forex broker can be high
As mentioned at the beginning, dealing directly with other market participants that include popular financial institutions comes with hefty requirements. One of the notable requirements is a high initial investment to start trading with a true ECN forex broker. Furthermore, since these brokers do not use trade spread for profits, but rather charge commissions unless a trader can place high volume trades, the whole process becomes highly expensive to sustain. Some brokers charge as much as $3.50 per trade, which can be significant for retail forex traders.
In summary, while using a true ECN forex broker brings with it many benefits to the clients, there are also a few notable drawbacks that prospective ECN traders should note. These can be very crucial when making the final decision to get in to forex trading. High net worth clients find ECNs very useful while small retail traders tend to opt for market makers due to limited financial outlay.
(Featured image by MaxxiGo via Shutterstock)
DISCLAIMER: This article expresses my own ideas and opinions. Any information I have shared are from sources that I believe to be reliable and accurate. I did not receive any financial compensation for writing this post, nor do I own any shares in any company I’ve mentioned. I encourage any reader to do their own diligent research first before making any investment decisions.
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