Electronic Communication Networks (ECN) are computer systems that facilitate trading within the stock market. Investors with access to level 2 quotes can view all ECNs that are active in any given stock. An ECN indicates how many shares are available to buy and how many shares are available to sell in real time. Investors and traders post orders into an ECN system and the ECN will match contra-side orders for execution. This means that all buy orders are matched on the other side (contra-side) with a sell order of equal price, and all sell orders are matched with buy orders at the same price.
Let’s take a look at a level 2 and explore a real life example of ECNs by exploring NFLX, which is the ticker for Netflix.
The level 2 indicates both the bid and ask. The current bid ($146.51) represents the highest price at which someone wants to purchase NFLX while the ask ($146.65) represents the lowest price at which someone wants to sell NFLX. There are dozens of ECNs that are actively engaged in the facilitation of trading on many stocks. Let’s take a look at the level 2 below to better understand some of the ECNs.
BATS – Stands for Better Alternative Trading System is one of the largest ECNs. BATS accounts for 10-12% of all US equity trading on a daily basis. Due to their size and influence BATS is considered to be a stock exchange.
NASD – This is the ECN that is owned and operated by the NASDAQ exchange.
EDGA/EDGX – Both of these ECNs are owned and operated by Direct Edge. These 2 ECNs account for 10-12% of all daily equity trading. Direct Edge, also considered a stock exchange and BATS are in close competition with each given their practically identical sizes.
ARCA – Archipelago Holdings was purchased by the NYSE in 2007 and the exchange became known as NYSE Arca. Arca handles the electronic trading business for NYSE.
BOST – Boston is a smaller ECN that was purchased by the Nasdaq exchange.
Next to each ECN are two pieces of information. The first number represents a price and the number following that represents how many shares (in hundreds) are matched with the price. It seems complicated but it is very straightforward. Going back to our level 2 we see on the top left side:
BATS 146.51 1. This means that within the BATS ECN network there are a total of 100 shares to be bought at $146.51. The order will be completed and filled when another investor or trader sells 100 shares of NFLX at $146.51 within the BATS network. A book is the term used to indicate how many shares are available within an ECN. When you have this information you say that you have the book. In this case there are 100 shares in the BATS book at $146.51
ARCA 146.65 1 This means that within the ARCA ECN network there are a total of 100 shares to be sold at $146.65. The order will be completed and filled when another investor or trader buys 100 shares of NFLX at $146.65 within the ARCA network. ECNs operate on a FIFO (first in first out basis) meaning the first order to be entered in the system is the first one that will be executed when matched.
It is important to understand that each ECN is independent of the others. In order for a transaction to occur a matching order within the same network must be met. For example an order to buy a stock sent within the ARCA network can not buy from the BATS network even if there are shares available in the BATS book. An investor however can buy on ECN and sell on a completely different one and this is a common strategy for high frequency traders.
About the author: Jayson Derrick is the director of trading at PromptTrader, an international proprietary trading firm that deals in US equities and options.
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