David Waring

What is an Electronic Communications Network (ECN)?


In our last lesson we continued our course on the logistics of stock trading, with a look at the NASDAQ stock exchange, and how stock trading is facilitated there through people who are known as market makers. In today's lesson we are going to continue this discussion, with a look at a relatively new way that traders can use to bypass the market makers, through something which is known as an ECN.

ECN stands for Electronic Communications Network, which is basically a computerized system that allows traders to bypass the major stock exchanges, and trade directly with one another. While ECN's are a relatively new phenomenon for the individual trader, they have actually been around for many years. Until relatively recently however, they were not available to the individual trader and were used exclusively by institutions and market makers. They used ECNs to bypass the exchanges and trade directly with one another, giving themselves access to favorable pricing, and the ability to trade after the exchanges closed for business. This not only lowered transaction costs significantly for the larger players in the market, but gave them the huge advantage of being able to execute stock trades after the exchanges closed, which is when most companies release their earnings.
Things went along this way until 1997, when people figured out that NASDAQ market makers were working together to keep the prices the public paid when trading on the NASDAQ high, and then trading amongst themselves at lower prices on an ECN called Instinet. In addition to bringing about a $1 Billion class action lawsuite which was taken against the market makers, this also caused the SEC to change regulations in a way that set the stage for trading on ECN's to be opened up to individual traders, as well as institutions and market makers.

We will get into the specifics of trading on ECN's in later lessons, however for now it is simply important to understand the following:

- ECNs are a byproduct of the continuous and rapid innovation that is happening in the markets as a result of technology.

- As they increase competition for the exchanges and give traders the opportunity to bypass market makers and trade directly with one another electronically, which drives down transaction costs for the individual trader.

- The are responsible for giving individuals the access to trade after hours, during the time when many companies relaese their earnings.

That's our lesson for today. In our next lesson we will begin a new module on how to place a stock trade with a look at the different types of quotes that are available to traders and how to read those quotes so I hope to see you in that lesson.

As always if there are any questions or comments please leave them in the comments section below, and good luck with your trading!

More on ECN's:

ECN: A new force in the stock markets? (Global Securities). | Banking & Finance > Financial Markets & Investing from AllBusiness.com
Electronic Trading Network
Guide to Day trading
Electronic Trading: Electronic Communications Networks (ECNs)
ECNs/Alternative Trading Systems

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Disclaimer: Trading is risky and can result in substantial financial loss. As always my posts are simply one traders opinion and should not be taken as trading advice. I am not a financial adviser so everyone please do their own analysis and take responsibility for their own trades.