Understanding ECN Order Flow Trading
ECN or Market-Maker Broker?
Debates over the suitability of ECN versus traditional market-making brokers tend to focus on the following issues, broadly as follows:
• minimum deposit sizes (higher with ECNs)
• spreads (lower with ECNs)
• commissions (higher with ECNs)
• execution (faster with ECNs but at more realistic prices)
• slippage (greater with ECNs)
• exposure to account losses (greater with ECNs)
These are all areas that any trader looking to open a new account should explore before making a final decision as to which type of broker is more suitable, before taking a closer look at the specific brokers themselves.
Missing from this equation is an important question: should a trader's trading style be a crucial determinant of this choice? The smart money's consensus is that it shouldn't, albeit with two exceptions. Firstly, scalpers tend to have an easier time with ECN brokers, even if only because many market maker brokers watch out for and ban this style of trading. Secondly, order flow traders have to use ECN brokers, as the information they need to make their trading decisions is only available through the platforms of ECN brokers.
What is Order Flow Trading?
Order flow trading relies on a simple theoretical basis: the only thing that moves the price is whether there are more buy or sell orders right now. It follows that if you look and see the price levels where clusters of buy and sell orders are placed, you can put the same type of order at or close to the same levels, and trade profitably along with the momentum generated by the crowd.
Price action / candlestick analysis trading follows the same logic by divining the footprints of order flow from the chart. True order flow trading takes things a lot further, however.
How Does Order Flow Trading Work?
The big players in the market are all using ECN-type trading. The essential point is that while most retail market-making brokers just show bid and ask prices, ECN traders can see the stop and limit orders that are actually sitting in the market waiting to be executed. Not only can they see the prices at which the orders are set to be executed, but their sizes as well: they can see the market depth.
Bear in mind that there is nothing to stop traders putting orders in some distance away from the current price, but then pulling the order out of the market before it actually gets executed. A clever order flow trader might be in a profitable long trade with the price at 90, but with the upward move running out of steam. He wants to drive it further, so he puts a huge sell order much bigger than his position in at 100. Other traders can see this order, which encourages them to buy, expecting to be easily able to get profitable sell orders filled at 100. The price rises, but the trader with the big sell order at 100 actually uses this buying to slowly sell his position. By the time the price hits 99, he has sold out all his position at higher prices, and he quickly removes his big sell order at 100. Mission accomplished for this trader.
This is a simple example of one of the games within games that order flow traders play, some very profitably. If you are ready and suitable for an ECN broker, a new world of opportunity might be beckoning.