ECN is the abbreviation for electronic communication network. An ECN is basically a computerized stock exchange that offers stock traders an alternative to traditional exchanges like the New York Stock Exchange. ECNs were created in 1969 by INSTINET and proliferated greatly during the 80s and 90s, but recently volume has shifted very heavily away from traditional stock exchanges to electronic communication networks.
The electronic communication networks as a whole are known as the LIT or Light pool markets. These are the markets that are available for all of the public to see. This is where about half of all volume transacts in the stock market, and they are open for access to any subscribers with a computer and internet access. Unfortunately few brokerages except for proprietary trading brokerages offer day trading accounts access to these networks. The opposite of LIT markets are dark pool markets. ECNs do not function primarily as dark pools, but some are now offering subscribers access to deeper pools of liquidity by offering some of their own dark pools.
The benefits of transacting over an ECN vs. a traditional exchange market are evident for a stock trader. An ECN seeks to remove the middleman by allowing a transaction to occur directly between market participants. ECNs have been credited with the massive reduction in trading transaction costs over time. Electronic exchanges removed the need for a trader to be on an exchange floor, so besides saving transaction costs, they also opened up market access to millions of traders who now only need a computer and an internet connection to participate in trading.
If a trader subscribes to an ECN, not only is she allowed to transact over the network, but she is also able to see the shares available to buy and sell on the ECN’s order books. This allows a trader to get an idea of buy interest vs. sell interest in a stock and can give a trader a read on the likely near term price movement. If the trader subscribes to the full suite of popular ECNs, they can choose to transact over the one that best suits their liquidity needs, balance fill potential with cost to transact. This gives the trader the highest probability of having the order transacted at the most beneficial price and cost to the trader.
The Most Active ECNs include:
NASDAQ: Including NASDAQ Boston exchange, and NASDAQ Philidelphia exchange
BATS BZX and BYX exchanges
Direct Edge EDGX and EDGA exchanges
Each ECN determines its own fee structure for transactions. It is common practice to pay a rebate to traders for either adding liquidity to its books or for removing it, and to charge a fee for the opposite order type. Depending on the pricing structure of a particular ECN, rebates offered can be as high as about $.003 per share, and costs can be as high as $.003 per share, but cost cannot be any higher than this by law. Some ECNs also offer incentives to transact higher volume over the network by paying higher rebates or reduced costs to those meeting certain volume thresholds for either adding or removing liquidity.
Because ECNs provide not only an inexpensive transaction medium for traders, but also rebates for certain order types, it is very advantageous for a trader to use a broker that will offer direct market access with pass through fees and rebates.
This is good for traders for a few reasons. For one it means that traders are charged on their volume transacted and not one flat fee. If a trader has a small order, they will pay a correspondingly small charge. Most traders are not trading anywhere near trade sizes that would approach the fees they pay with a retail broker. For a traditional retail broker to save a trader money over pass through ECN charges each trade placed would have to be many thousands of shares and a trader has no access to rebates. Under a typical fee structure a brokerage can collect fees from the trader for placing the trade, and then turn around and collect fees from the ECNs for transacting with them.
Awareness amongst traders at this time that this type of pricing is available to them is generally very low and most traders stick with the big name retail brokerages out of familiarity and the lack of licensing needed to have accounts with them.
At How We Trade, we use a broker that will completely pass through all rebates and costs for trading over ECNs.