ECN stands for Electronic Communications Network, which is basically a computerized system that allows traders to bypass the major stock exchanges, and trade directly with one another. While ECN’s are a relatively new phenomenon for the individual trader, they have actually been around for many years.
- ECNs are a byproduct of the continuous and rapid innovation that is happening in the markets as a result of technology.
- As they increase competition for the exchanges and give traders the opportunity to bypass market makers and trade directly with one another electronically, which drives down transaction costs for the individual trader.
- The are responsible for giving individuals the access to trade after hours, during the time when many companies release their earnings.
However, they were not available to the individual trader and were used exclusively by institutions and market makers until relatively recently. They used ECNs to bypass the exchanges and trade directly with one another, giving themselves access to favorable pricing, and the ability to trade after the exchanges closed for business. This not only lowered transaction costs significantly for the larger players in the market, but gave them the huge advantage of being able to execute stock trades after the exchanges closed, which is when most companies release their earnings.
Things went along this way until 1997, when people figured out that NASDAQ market makers were working together to keep the prices the public paid when trading on the NASDAQ high, and then trading amongst themselves at lower prices on an ECN called Instinet. In addition to bringing about a $1 Billion class action lawsuit which was taken against the market makers, this also caused the SEC to change regulations in a way that set the stage for trading on ECN’s to be opened up to individual traders, as well as institutions and market makers.