Broker to Trading

ECN brokers offer traders access to liquidity outside of the broker. ECN brokers aim to let the trader in effect more directly access the Forex market through the broker. Forex is not traded on exchanges and is decentralised. However there is a centralising structure to the Forex market based on who the big players are. These are banks and other participants who trade very large volumes for a range of purposes.

Typically retail traders who have an account at a broker are cut off from this market and trade with the broker. However ECN brokers let trader access liquidity providers the broker uses, which can include banks, hedge funds and dark pools, but through the broker. For the most liquid Forex pairs, spreads from these providers can be very low. However there is normally an additional cost, which is the commission charge added to the cost of the spread by the broker.

Because the major participants trade large volumes, Forex has a relatively high unit cost. One lot is $1,000,000 in the Interbank market. So to be usable for retail traders who will generally be trading much smaller volumes and have smaller account sizes, a number of reductions take place. Firstly, a standard Forex lot is $100,000 (though an ECN broker may set a lot at $1,000,000), using a USD example on this page with a pip value of $10 (depending on the account currency and the Forex pair, the actual value of a pip per lot can vary). But this is still a large sum for many traders just to trade a lot let alone multiples of a lot.

So Forex brokers (including ECN brokers) have typically taken a number of routes to allow the retail trader to trade Forex. One is to reduce the size of lots, which can be as small as 0.001 lots or even smaller with a Forex cent account. Another route is to allow relatively high leverage. This means that the trader can control (i.e. trade) larger Forex volumes with less capital. Forex brokers have traditionally offered relatively high maximum leverage for Forex, 500:1 is not unusual.

1:1 leverage means that the trader controls $100,000 with $100,000. 500:1 leverage means that the trader controls $100,000 with 1/500th of this amount, namely $200. Thus with $200 on margin the trader can trade with a pip value of $10. This may seem attractive, but it can potentially be problematic, because it could mean that a small account size can open a trade where each move is worth $10. The Forex market moves in complex ways and moves of 30 pips or more are not unusual and can happen rapidly. A stop out could be triggered, liquidating positions to protect the capital in the account if the move is against the traded position. Increasing leverage increases risk. The ratio of the capital in the account to open positions can be a critical factor in trading. By reducing trade sizes, e.g. reducing order size multiples and using mini lots, or micro lots or a cent account, the pip value is reduced. Thus for one micro lot (0.01 standard lots), the margin required in the example is $2.00, with each pip worth 10 cents.

As ECN brokers are primarily Forex brokers, they traditionally offer high leverage, as well as typically smaller lot sizes, which can be a way to reduce leverage. ECN brokers also offer other CFD markets, allowing the trader to trade a range outside of Forex, but these may be offered with considerably lower maximum leverage.

While the cost of a trade is not necessarily lower than at other brokers (as it consists of the spread plus the commission charge), ECN brokers typically provide high speed order execution. They may do this by co-locating their servers with other market participants in data centers using technology such as fiber optical cables for high speed order transmission or other ways to utilise centralisation and low latency technology in a distributed market.

Because the broker is connecting trader with liquidity through the broker they will typically provide no dealing desk conditions, allowing the trader to use a wide range of trading styles. This can be a consequence of not intervening in the order process and the capacity to process orders in a rapid manner. ECN brokers may be a broker of choice for automated traders, but they can be used by discretionary traders as well and can offer platforms with a wide range of trading tools such as technical indicators, which may be of interest to discretionary technical traders.