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An electronic communication network (ECN) is the phrase used in financial circles for a computer system that smooths the progress of trading financial products outside stock exchanges. The products that are traded on ECNs are primarily stocks and currencies. ECNs were created in 1998 when the United States Securities and Exchange Commission authorized their creation. ECNs augment competition amongst trading firms by decreasing transaction costs, giving clients complete access to their order books, and allowing order matching outside normal exchange hours.
To trade with an ECN, you have to be a subscriber or have an account with a broker that gives direct access trading. ECN subscribers can enter orders into the ECN through a computer terminal or network. ECNs include Island, Market XT, Archipelago and Instinet, among others. The ECN will match sell orders to a buy-order with the same price and share count and process it for execution. At the same time, the ECN posts unmatched orders on the network for other subscribers to view. The buyer and seller are usually anonymous; the trade is reported listing the ECN as the buying or selling party.
Some ECNs will offer more features to subscribers, such as negotiation, reserve size, and pegging. The subscriber may be allowed access to the whole ECN book containing vital real-time market data concerning depth of trading interest. Used in conjunction with a stock chart service or technical analysis software, the ECN can change the dynamic of an average investor's trades.
The appearance of electronic trading venues in the late 1990's made it feasible for more investors to trade after normal exchange hours. Theoretically, an investor who makes arrangements to access an electronic communications network can trade in the after-hours marketplace.
It is important for the investory to understand that some ECNs are regulated exchanges, while others are sidelines for broker and dealers, and others are completely unregulated.
ECN's fee structure can be defined in two key structures: a classic structure and a credit (or rebate) structure. Both types have their own advantages. The classic structure attracts liquidity removers, while the credit structure appeals to liquidity providers. Since both removers and providers of liquidity are crucial to creating a market, however, ECNs must choose their fee structures carefully.
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