Electronic communication networks ecns

Electronic Communication Networks are broker-dealers that facilitate two-sided order flow through an electronic medium. An ECN is a privately maintained market, employing various methods of electronically matching orders. The popularity and liquidity of ECNs exploded in the late 1990s, after NASDAQ changed its order handling rules in 1997 requiring increased visibility, which is the ECNs' specialty. ECNs today account for almost 30 percent of the total volume traded on NASDAQ. It is estimated that by the year 2001, more than half of the total volume traded on NASDAQ will emanate from ECN order flow.

With the limit order regulatory changes imposed by NASDAQ, ECNs have become a popular way for on-line investors and traders to display their orders. Institutions and market makers often frequent ECNs for anonymity and liquidity, resulting in less market impact cost.

The NASDAQ stock market is primarily a dealer-driven market that requires human involvement in order to facilitate order flow. ECNs are automated systems that match orders on an electronic book. NASDAQ is electronic, but it is decentralized, acting as an electronic messaging system dependent upon market makers.

The long-term viability of ECNs is questionable, however, because of the inevitable move of NASDAQ away from fragmentation and toward centralization and automation. If NASDAQ has its own central order book, then the need for the fragmented ECNs will disappear.

When a market maker receives an institutional order, the first objective is to buy or sell the stock discreetly, so as not to attract any unwanted attention. Institutions are best served when their orders are executed without any market impact cost. Institutions prefer to trade their merchandise with other "natural" merchandise, so they receive better prices without affecting the natural price of the market. Market makers are increasingly using ECNs to lessen the market impact of an order.

The advantage of a market maker using an ECN instead of its own name is that it will have less of a chance to alarm other players. If a market maker who is a known AX in a relatively illiquid stock suddenly moves the market to the inside bid, other market makers and traders may scramble to buy the stock first.

Market makers utilize all the tools at their disposal, including ECNs, to get the job done effectively for their clients or for themselves.

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