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Fourth Markets

This overview explores Electronic Communication Networks (ECNs), a modern approach to trading that allows individuals and institutions to directly buy and sell stocks and currencies outside of traditional stock exchanges. Originating in 1969 with Instinet, ECNs provide crucial advantages, including favorable pricing, after-hours trading, and anonymity. As retail participation has surged, ECNs now play a pivotal role in the trading landscape, offering various benefits and challenges compared to conventional trading methods. Discover how ECNs function and their impact on today's financial markets.

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Fourth Markets

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  1. Fourth Markets Crystal Cady • BA543 Spring 2013

  2. Brief Introduction to ECN’s • Off-exchange trading in the market • Computerized system that allows traders to bypass major stock exchanges, brokers & trading floors • Primary products traded are stocks and currencies • Considered ‘fourth market’ • Relatively new phenomenon for individual traders • Until recently were only used by financial institutions and market makers • Sanctioned by the SEC • Played a key role in growth of ECN’s

  3. Why ECN’s? • An alternative to the conventional equity trading arrangements • ECN’s were created to bypass the other exchanges and trade directly with one another • Access to favorable pricing • Ability to trade after-hours • Designed to be a trading system for institutional investors • Allows traders to meet in an anonymous market • Allows for trades all over the world regardless of physical location

  4. History of ECN’s • Began operating in 1969 • Instinet was the first ECN • Operated similar to broker-dealer for nearly 30 years • SEC imposed order handling rules in 1997 • Created a new category that applied to Instinet (ECN) • Allowed for individual (retail) trading in addition to institutional • Negative effect on NASDAQ • Number of ECN’s rose significantly • Resulted in major loss of volume in under two years

  5. History of ECN’s • New entrants in the 90’s took on retail flow • By 2000 nearly a dozen ECN’s existed • Archipelago bought Pacific Stock Exchange to become the first fully electronic stock exchange • Consolidations reduced the number down to a few • Once only larger players remained several applied to SEC to become an exchange • Allowed for faster, more direct transactions

  6. Today’s Major ECN Players • Bloomberg Tradebook • LavaFlow • A division of CitiBank • ArcaEdge • Merger of Redibook and Archipelago

  7. How ECN’s Work • Two main types: Retail & Institutional • Pass on prices from multiple market participants • Display the best bid/ask quotes on platforms • ECN- brokers also serve as counterparties to forex transactions • What is a forex transaction? • Make money by charging customers a fixed commission for each transaction

  8. How ECN’s Work

  9. Pro’s of ECN’s • Achieve better bid/ask prices • Can trade on prices with little or no spread • Why is this important? • Genuine ECN brokers will not trade against you • Prices may be more volatile • Better for scalping purposes • Can take on role of market maker

  10. Con’s of ECN’s • Many don’t offer integrated charting & news feeds • Trading platforms tend to be less user friendly • Difficult to calculate stop-loss and breakeven points in advance • Traders have to pay commissions per each transaction TIP: Get yourself a good broker!

  11. Questions?

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