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What is an 'Electronic Communication Network (ECN)'

An electronic communication network (ECN) is an automated system that matches buy and sell orders for securities. It connects major brokerages and individual traders so they can trade directly between themselves without going through a middleman and make it possible for investors in different geographic locations to quickly and easily trade with each other. The U.S. Securities and Exchange Commission (SEC) requires ECNs to register as broker-dealers.

BREAKING DOWN 'Electronic Communication Network (ECN)'

Classified by the SEC as an alternative trading system (ATS), an ECN makes money by charging a fee for each transaction to meet financial obligations. It attempts to eliminate the third party’s role in executing orders entered by an exchange market maker or an over-the-counter market maker, and permits such orders to be entirely or partly executed. Orders placed through ECNs are usually limit orders.

Functions Provided by an Electronic Communication Network

ECNs are computer-based systems that display the best available bid and ask quotes from multiple market participants, and then automatically match and execute orders. They not only facilitate trading on major exchanges during market hours, they are also used for after-hours trading and foreign currency trading. ECNs allow for automated trading, passive order matching and speedy execution. Some ECNs are designed to serve institutional investors, while others are designed to serve retail investors.

Examples of Electronic Communication Networks

Some of the different ECNs include Instinet, SelectNet and NYSE Arca. Instinet was the first ECN, founded in 1969, and is used by small brokerages and for transactions between institutions. It is widely used by market makers for NASDAQ trades, but individuals and small firms can also use it. SelectNet is used primarily by market makers, but it does not require immediate order execution and helps investors trade with specific market makers. NYSE Arca grew out of the merger between the New York Stock Exchange (NYSE) and Archipelago, an early ECN from 1996. It facilitates electronic stock trading on major U.S. exchanges such as the NYSE and NASDAQ.

Other Alternative Trading Systems

Along with ECNs, matching systems and call markets are also considered forms of an ATS. Matching systems receive orders and route the activity through a matching engine instance where the prices are checked against current resting limit orders. If no match is found, the order is placed in the book immediately as a quote. Call markets accept orders one at a time, with buying and selling prices determined based on the exchange activity after the order is placed.

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