They function as an exchange floor, except that orders are filled electronically and there is no trading floor. Currently, two of these networks trade stocks that are listed on the NYSE. They are INET and ARCA. ARCA recently merged with the NYSE. Although the future is unclear on this merger, one thing is sure: Speed will increase and transaction costs will decrease. Both very good things for the trader.
ECNs work on a first-come, first-served basis. If the orders match, these transactions usually take a fraction of a second. When a buy order at $35 hits the network and a sell order at $35 is present, you have a match. The order executes almost instantaneously.
Because of their speed, ECNs are very popular. They now account for a large proportion of daily stock trades. I am sure this will continue to increase in the future.
ECNs were introduced in 1969. They provided a way for institutions to display their buy and sell orders on the Nasdaq. It was also the start of electronically executed trades. Prior to this, a Nasdaq trader had no way of executing trades except via the telephone. ECNs sped up the process by having every trade executed electronically. There is a lot less handling, and transactions now occur in fractions of a second instead of minutes. All orders on ECNs are firm orders. This means the trader who placed the order does not have the choice of accepting or declining a matching order. As soon as a matching order arrives into the network, the trade is executed. In a fast market, this feature is priceless. It allows traders to get in and out of their positions quickly.
In 1996, the introduction of a new ECN called Island (ISLD) allowed small traders like you and me to access the Nasdaq directly. Prior to ISLD, the ability to buy and sell directly in the Nasdaq market was available only to large institutions.
Since then, many new ECNs have been established. Island and Instinet joined forces to become INET. Brut is the Nasdaq’s ECN. ARCA, as mentioned earlier, has merged with the NYSE. Changes and consolidation will continue. (Note: As of this writing the Nasdaq is awaiting regulatory approval of its proposed acquisition of INET.)
How ECNs Work
As mentioned earlier, ECNs function as regional exchange floors. They have their own individual markets and allow traders to trade directly with each other. ECNs accept both trader (individual) and broker (institution) orders. Do not automatically assume an ECN order to be from a trader like you and me. It could be a market maker trying to hide his or her true identity and intentions.
ECNs do not provide capital to facilitate trades. They serve only as a conduit or intermediary to the market. They give the trader a medium for order placement and execution. They compete directly with market makers for order flow. They have no vested interest in the price of a stock. They now account for a very large proportion of Nasdaq’s total daily volume.
Traders enter bids and offers on a national system that is visible worldwide. Real-time visibility and volume equal liquidity. That’s why traders get fast results.
The three main ECNs available to daytraders are:
- Inet (INET)
- Brut (formally owned by SunGard Data and now owned by Nasdaq Stock Market, Inc.)
- 3 Archipelago (ARCA), which recently merged with the NYSE Other ECNs, playing smaller roles, include:
● Bloomberg Tradebook (BTRD)
● Attain (ATTN)
● NexTrade (NTRD)
REGULATORY FRAMEWORK
The NASD is a self-regulatory organization. It polices Nasdaq trading and the overall OTC market. The Securities and Exchange Commission (SEC), however, has the ultimate authority to enforce securities laws and regulations. The SEC also supervises and acts as a safety net for securities markets. The SEC constantly updates its policies and has the authority to mandate changes to NASD rules and regulations.
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