Trading Forex is not something to jump straight into. You first need to make sure you are dealing with a broker you can trust, one which has a service that is best suitable for you. To that end, you should consider a lot of things – the company’s regulations, its trading conditions, and so on. A particularly important aspect to take into account is exactly how the broker functions – is it a Market-Maker, an STP, or an ECN broker?
Much can be said about the differences in these three business models – however, in the article below, we will focus just on ECN brokerages. The most distinct difference from the other two types is that the ECN (Electronic Communication Network) broker puts you in direct contact with a liquidity provider be it a financial institution, or other traders in the network, which facilitates your trading. Therefore, unlike STP brokers, the trades are executed with a much higher degree of transparency. And, unlike Market Makers, the broker does not bet against you – the firm, therefore, does not have an interest in you losing money.
There are more advantages that could be mentioned when talking about ECN forex brokers – there is the lower, or zero, spread and the lack of requotes, for example. However, there are also some downsides to trading with this kind of broker as well. It is important to consider them when you are picking a broker to trade with, so we have covered them in more detail below:
Higher costs to open an account
An obvious disadvantage to trading with an ECN broker as opposed to an STP one is the much higher average minimum deposit. ECN brokers are not geared toward offering their service to small retail traders – their target client is one that knows how to make the best use of the direct connection to liquidity providers these brokers offer. Therefore, it is common practice for an STP broker to open a micro account, costing anywhere from $1 to $10.
An ECN account, at the other hand, usually requires a minimum deposit of between $500 and $1000. This is not only less accessible to a lot of smaller retail traders, but also means they incur a higher risk by depositing and trading with more money they could lose!
Higher trading costs for low-volume traders
A significant difference between STP and ECN brokers is their pricing models. STP brokers charge you markups on spreads and commissions on the opening and closing of each trade. On the other hand, ECN brokers only take money from you via commissions on the opening and closing of each trade.
There are advantages and disadvantages to both of these pricing models. The biggest advantage to trading with an ECN broker is the low cost of trading for high rollers. However, most ECN brokers charge a minimum commission per side, no matter the size of the trade – e.g. $3 per $100 000 traded, but not less than $1 per trade. This makes trading with a small account and lower volume rather disadvantageous. The cost of opening and closing trades could add up rather fast and overwhelm you.
Micro lots unavailable
Another disadvantage to ECN brokers is that the majority of them do not actually allow you to trade with micro-lots. A lot is a unit that measures the volume of an asset you are trading. The standard lot in Forex is worth 100 000 units of a certain currency. A mini lot is worth 10 000, and a micro lot is worth 1 000 units of said currency. Most STP brokers have no issue with you trading with these smaller units, and are able to execute trades with micro lots.
However, the average ECN broker seeks to attract a different trader than the retail investor with lower amounts of capital who might prefer to place some smaller-scale trades. Therefore, such brokers usually avoid allowing you to trade with a micro lot and have a mini lot as the smallest unit of currency that could be traded.
Possible negative slippage
Slippage is a term that denotes an increase or decrease in the price of an asset between the time an order is placed and the time it is executed. This results in the trader dealing with different conditions than they intended. You could therefore suffer losses as the broker executes the trade at the next best price.
Slippage is a side-effect of the volatility of trading Forex – and it is more severe the more volatile the markets are. There are many complex factors that cause volatility in the markets. Therefore, even with an ECN broker, you could end up with a different trade than intended due to different economic news around the world, or simply because you are trading outside of the peak market hours for the asset. These are costs that should still be taken into account, even with ECN brokers!
So, who should trade with ECN brokers?
In conclusion, and, as you might have summed up yourself, the main advantages and disadvantages of ECN brokers are tied to the nature of their business model. This model facilitates the placement of high-volume trades and is less accessible to clients with lower amounts of capital. Therefore, smaller retail traders and clients who are just starting out do not really have a place among the clients of an ECN broker. They are much better placed at trading with a broker that is able to provide them with a service at a lower cost – an STP one.
On the other hand, if you are a confident trader who knows what they are doing, an ECN broker is the best place to put your aptitude to practice. Trading with these companies is beneficial since it allows you to access a depth of the market that is simply not available with your average STP broker.
The good news is that the biggest brokers nowadays regularly allow you to have access to both modes. Therefore, once you know the broker you are dealing with is legitimate, you can access the advantages and disadvantages of both at ease, and pick the right mode of trading for yourself!