How ECN Brokers Work?
When you are going to choose a Forex broker, you will hear a lot of people talk about the benefits and drawbacks of going with an ECN broker. What is an ECN broker and what is the difference between an ECN broker and a common retail Forex company (market maker)?
ECN stands for Electronic Communication Network. ECN brokers are in direct communication with various market participants within a comprehensive interbank network. This allows ECNs to offer the best prices to their clients on trades. ECNs are not necessarily better than retail Forex companies. What is best for you depends on your circumstances.
A lot of people argue about whether you trade against your broker or against other traders in Forex. This comes from an essential misunderstanding about how Forex brokers work. Not all brokers work the same way. When you trade with a retail Forex company, the retail Forex company takes the other side of your trades. When you trade with an ECN, you are paired up with an actual trader who trades against you.
Many people believe (correctly or incorrectly to a varying degree) that retail Forex companies manipulate prices, widen spreads, and otherwise attempt to make money off of you when you trade. Since they are trading against you, it is indeed to their advantage. The majority of retail Forex brokers do not really have to do this though since the majority of Forex traders lose most of the time. Will you get less slippage and tighter spreads with an ECN? Yes, but you will also have to pay commissions. Nonetheless, a lot of traders consider an ECN model to be more reliable and a better deal.
You can get higher leverage with retail Forex brokers and start out with smaller accounts (whether you choose to accept the advantage of the higher leverage or not is another question). With an ECN, you will need a good amount of money to open an account. A lot of Forex daytraders favor ECNs though since the price which is quoted is often more reliable with an ECN. Wealthier traders often switch their retail accounts over to ECNs after they have enough funds since they enjoy the increased feeling of security they get from trading with ECNs. Forex ECNs often do not borrow your money for use in their own transactions and most often let you your money in a standard bank account if you can get your bank to issue a guarantee on your trades.
If you are just starting out and you do not have a lot of money, you will probably need to trade with a retail Forex broker. Their platforms are often more sophisticated and easier to use, and the smaller account sizes will be more palatable to most new traders. You can demo forever on a retail trading account without investing a dime, which makes it a great way to learn how to trade. You will not have to pay commissions, and often times, you can learn to predict when spreads will widen (such as after weekends) by demo testing. Once you have more money in your trading bankroll you may want to switch to an ECN at your own discretion.