ECN originally stood for an electronic communication network, a description that falls well short of describing its purpose. ECNs developed around the beginning of the internet to allow stock traders to freely trade with one another and bypass the exchanges. The system added a dramatic increase in pricing and transparency. That’s why the investment banks bought them all out; they don’t want the small fish thinking that they deserve actual price discovery and low costs.
Fast forward twenty years and everyone bounces the word back and forth like it applies to the retail forex market. Well, it doesn’t, but I know that I’m going to lose this battle. The real structure of an ECN offers all participants the ability to act as price takers or market makers. With the exception of MB Trading, every single MT4 broker today only offers half of what an ECN offers. Traders either accept the prices appearing on the screen or they do not. The brokers don’t offer any alternatives. The word ECN in popular parlance has been debased to mean a brokerage that is passing liquidity from one side to another.
This structure, in my opinion, is one of the largest ills of the retail forex market. Everything about the system encourages traders to act as captive sheep. They can only accept the prices that the broker deigns to offer.
Although the stock market is also corrupt, at least setting a limit order actually shows through on the ticker. Most forex traders, amazingly, are not aware that this is how most markets work.
Consider a currency that trades at a bid-ask spread of 145-147 with a typical forex broker. If I want to buy at 146 limit, I must wait for the ask to drop to 146 before my order will fill.
The same order traded in the equities or futures markets would behave completely differently. The spread changes the exact moment that I post my 146 buy limit. The spread now appears as 146-147.
I do the market a favor by posting my order out there. The spread decreases, reducing the spread cost for the next person to sell a position. Additionally, that trader got to sell a whole point higher at 146 instead of 145. It works to everyone’s benefit.
Go back to the definition of a limit order. It means an order to buy at a price better than the prevailing market. That action requires a seller. Otherwise, no trade would occur. The broker or exchange posts that buy order for whichever seller wants to come along and take me up on the trade.
You can think of it just like eBay. My limit buy order is like the auction advertisement. eBay is like the broker. The person going short acts like the person buying used stuff off of the internet. Both parties walk away happy with the trade. The purchaser trades cash for goods. The person listing the auction trades goods for cash. eBay gladly stands in the middle and takes a small commission for the service. That is genuine price discovery.
For all the silly rules that the NFA creates, the one that they ought to focus on is this complete lack of price discovery. Any brokerage promoting themselves as an ECN ought to actually offer the services of a real ECN.