Currency ECNs

The forex dealer described in the previous section has been joined by a different breed of forex trading firm: online “currency ECNs” or currency order-execution systems (COES). The difference between the two is that COES, similar to their stock ECN counterparts, match orders: They allow clients to trade against each other’s bids and offers, rather than (or in addition to) the dealer’s.

Such systems typically display order books similar to stock ECNs such as Island, with bids and offers representing tradable prices. Traders can post bids and offers in a “transparent” book similar to that of the Nasdaq Level II quote screen, which shows all the levels of bids and offers, not just the inside quote (lowest offer and highest bid). A few examples of this type of firm include MatchbookFX (www.matchbookfx.com), HotSpotFX and HotSpotFXi (www.hotspotfx.com), and CoesFx (www.coesfx.com). “We’re an open marketplace,” says MatchbookFX president and CEO Mark Smith. “We just facilitate transactions.”

These kinds of firms are often targeting smaller institutional and corporate businesses that do not get preferential treatment from the direct interbank market (although many also accept retail-size accounts of $25,000 or less).

In addition to customer orders, some COES use in-house traders who provide additional liquidity to the market. According to Smith, these traders act “similar to specialists on a stock exchange floor. Their job is basically to control the markets when they get out of whack because of a lack of liquidity, and to handle the stop-order book. They don’t take proprietary trades; they just facilitate entries and exits for the customer.”

What advantages over the typical forex market do these firms see in their models?

“We allow all of our customers to trade FX on equal footing,” says John Eley, HotSpot’s chief executive officer. “All participants see the same dealable prices.”

The key to the FX world, as it stands, is finding a good platform that has the lowest spreads. However, “there are leaps coming shortly that will eliminate fixed spreads, which will make this market more accessible than it already is,” says Chris Mercer, trader and owner of Tradesight.com, an educational Web site providing market education, analysis and trading strategies.

In August, Mercer partnered with EFX Group/Arizona, a direct-access brokerage firm for FX traders, managed by Jon Floyd.

“Soon we’re going to take the deal desk away and make FX a more level playing field,” Floyd says. “We’ll have a platform that will allow clients to deal directly with each other.”