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An electronic communication network ECN is a type of computerized forum or network that facilitates the trading of financial products outside traditional stock exchanges. An ECN is generally an electronic system that widely disseminates orders entered by market makers to third parties and permits the orders to be executed against in whole or in part.
The primary products that are traded on ECNs are stocks and currencies. ECNs are generally passive computer-driven networks that internally match limit orders and charge a very small per share transaction fee often a fraction of a cent per share.
ECNs increase competition among trading firms by lowering transaction costs, giving clients full access to their order books, and offering order matching outside traditional exchange hours.
To trade with an ECN, one must be a subscriber or have an account with a broker that provides direct access trading. The ECN will then match contra-side orders i. The ECN will post unmatched orders on the system for other subscribers to view. Generally, the buyer and seller are anonymous, with the trade execution reports listing the ECN as the party.
Some ECN brokers may offer additional features to subscribers such as negotiation, reserve size, and pegging, and may have access to the entire ECN book as opposed to the "top of the book" that real-time market data regarding depth of trading interest. ECNs are generally facilitated by electronic negotiation, a type of communication between agents that allows cooperative and competitive sharing of information to determine a proper price.
The most common paradigm is the electronic auction type. As ofmost e-business negotiation systems can only support price negotiations. Traditional negotiations typically include discussion of other attributes of a deal, such as delivery terms or payment conditions. This one-dimensional approach is one of the reasons why electronic markets struggle for acceptance. Multiattributive and combinatorial auction mechanisms are emerging to allow further types of negotiation.
Support for complex multi-attribute negotiations is a critical success factor for the next generation of electronic markets and, more generally, for all types of electronic exchanges. This is what the second type of Electronic negotiationnamely Negotiation Support, addresses. While auctions are essentially mechanisms, bargaining is often the only choice in complex cases or those cases where no choice of partners is given.
Bargaining is a hard, error-prone, ambiguous task often performed under time pressure. This requires agents to be able to reason about the mental states of other market participants. One research area that has paid particular attention to modeling automated negotiations is that of autonomous agents.
If negotiations occur frequently, possibly on a minute per minute basis in order to schedule network capacity, or negotiation topics can be clearly defined it may be desirable to automate this coordination. Automated negotiation is a key form of interaction in complex systems composed of autonomous agents. Negotiation is a process of making offers and counteroffers, with the aim of finding an acceptable agreement.
During negotiation, each offer is based on its own utility and expectation of what other. This means that a multi criteria decision making is need to be taken for each offer. ECNs, as alternative trading systems, have increased competition with institutional trading systems.
Alternative trading systems have been found to have lower execution costs, however as new ECNs emerge, some of this cost reduction has dissipated. ECNs have influenced the stock market by eliminating dealer functions in order-matching. With the automation of orders on mass scale, the role of intermediary traders has been reconfigured. ECN's fee structure can be grouped in two basic structures: Both fee structures offer advantages of their own. The classic structure tends to attract liquidity removers while the credit structure appeals to liquidity providers.
However, since both removers and providers of liquidity are necessary to create a market, ECNs must choose their fee structures carefully. In a credit structure ECNs make a profit from paying liquidity providers a credit while charging a debit to liquidity removers. The fee can be determined by monthly volume provided and removed, or by a fixed structure, depending on the ECN.
Traders commonly quote the fees in millicents or mils e. In a classic structure, the ECN will charge a small fee to all market participants using their network, both liquidity providers and removers.
They also can attract volume to their networks by giving lower prices to large liquidity providers. This was quite unique at the time, as it empowered buy-side FX market participants, historically always "price takers", to finally be price makers as well. Today, multiple FX ECNs provide access to an electronic trading network, supplied with streaming quotes from the top tier banks in the world. Their matching engines perform limit checks and match orders, usually in less than milliseconds per order.
The matching is quote driven and these are the prices that match against all orders. Spreads are discretionary but in general multibank competition creates pip spreads on USD Majors and Euro Crosses. The order book is not a routing system that sends orders to individual market makers. By trading through an ECN, a currency trader generally benefits from greater price transparencyfaster processing, increased liquidity and more availability in the marketplace.
Banks also reduce their costs as there is less manual effort involved in using an ECN for trading. The NASDAQ system automated such order processing and provided brokers with the latest competitive price quotes via a computer terminal. In Marcha study by two economists, William Christie and Paul Schultz, noted that NASDAQ bid—ask spreads were larger than was statistically likely, indicating "We are unable to envision any scenario in which 40 to 60 dealers who are competing for order flow would simultaneously and consistently avoid using odd-eighth quotes without an implicit agreement to post quotes only on the even price fractions.
ECNs enjoyed a resurgence after the adoption of SEC Regulation NMSwhich required "trade through" protection of orders in the market, regardless of where those orders are placed.
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