Table of Contents
2. Main advantages and disadvantages of ECNs
3. The future of ECNs and Instinet’s increased competition
ECN is the acronym for “Electronic Communication Network”, an electronic system that facilitates the trading of financial products outside the usual stock exchanges. By introducing an ECN, trades can be completed directed without the need of a middleman or third party. Of course, there are fees connected to the usage of an ECN.
The ECN connects buyers and sellers, also matches buy and sell orders at specified prices and detects whether there are matches between these two parties (Appendix A). The main products traded through the ECN are equities and foreign exchange. The brokers are entitled to enter their orders or the orders of their customers in the system. At the beginning, only large investors could use the system, but the SEC changed the law and made small investors also a beneficiary of the system. ECNs increased the volume of trading of smaller investors and provide anonymity to investors. Still not everyone can use an ECN and trade on one since an investor has to be subscribed to an ECN. Another possibility for an investor to trade on an ECN is to have an account with a dealer or broker who is already registered. The ECNs have allowed a reduction of brokerage commission due to a reduction of the costs within the brokerage firms. Furthermore, additional value is provided by the system, as it reduces the time needed for transactions (Bodie, Kane & Marcus, 2010).
The SEC allowed the usage of ECNs in the United States in the late 1990’s, but the peak was reached in the following decade. Nowadays, traders all over the world use these types of systems to make a deal. ECNs are categorized as alternative trading systems (ATS) by the SEC. Each stock exchange has its own ECN supplier, the London Stock Exchange for example uses the Stock Exchange Electronic Trading Service, Euronext that was formed by Paris. Amsterdam and Brussels on the other hand, use Nouveau Systeme de Cotation or New Quotation System. It is proven that ECNs have increased the efficiency of the stock market.
The purpose of this report is to clarify the concept of ECNs and Instinet’s role in this market and its difficulties with the rising competition.
First, the report discusses the main advantages and disadvantages offered by ECNs. Then, the report looks at the future of ECNs and how Instinet can counter the increased competition. Finally, there will be a short conclusion.
2. Main advantages and disadvantages of ECNs
Traditional trading systems are losing their importance due to the advantages offered by ECNs. ECNs are able to display orders in real time, which enables an automatic match of buy and sell orders at specified prices. Furthermore, as brokers are not needed anymore pre-transaction costs are reduced and as well as the transaction time. The reduction in transaction costs is partially caused by the elimination of hidden costs due to the presence of brokers. In addition, this also leads to direct trading between investors. Another advantage of ECN’s is the possibility to trade round the clock since investors are not dependent on the opening and closing times of the stock markets around the world. The anonymity of investors is another advantage offered by ECN’s. Moreover, these systems offer a wide range of information such as last sale prices and waiting sale prices, as well as information on short-term market trends (Bodie, Kane & Marcus, 2010).
However, ECN’s also have got some disadvantages. It becomes more difficult to match buyers and sellers as trading volume increases, as well as not operating on the same ECN. The consequences were that some deals did not take place. Implementing advanced software algorithms solved the difficulty with increased volume of trading. Furthermore, there were high commission to be paid on every trade and hence traders experienced losses since their earnings were less than the commission they had to pay. As prices in traditional systems were more stable due to simplicity to find large sellers and buyers, the spread of stocks during the day was lower than the spread of stocks during the night. This is because during nights only ECN’s are operating (Bodie, Kane & Marcus, 2010).
- Quote paper
- Maximilian Wegener (Author)Carlos Lasure Briz (Author)Janis Klenk (Author)Christine Nicoll (Author)Julia Savvopoulos (Author), 2012, Instinet - The usefulness of ECNs in trading environments, Munich, GRIN Verlag, https://www.grin.com/document/215075