Overview
Liquidity can be defined as the ease with which financial instruments can be bought, sold, and thereby converted into cash without it affecting the market price or exchange rate.
The foreign exchange market typically referred to as the forex or FX market, is the most liquid financial in the world because of the massive trading volumes experienced daily. The trading volumes experienced daily amount to over 89 billion ZAR, with millions of participants actively buying, selling, and trading forex pairs.
Participants include retail forex traders, hedge funds, banks, and several others, who trade forex either for business purposes or to earn a profit through speculative trading strategies.
Understanding the role and importance of Liquidity
The principle behind liquidity is how fast a trader can turn their financial instrument or currency pair into cash, without the exchange rate being affected. If an investor buys the share of a company, the transaction could take up to five business days to be completed.
With a forex transaction, execution can take at most two business days, with the Canadian Dollar and the United States dollar, or CAD/USD, the exception as this transaction takes a day.
Several financial markets typically experience low liquidity because of the value of transactions and the frequency of deals being closed, for instance, the real estate market. Transactions in the real estate market can take anywhere from two days up to a few years to settle.
The term “Liquidity Provider” in forex and CFD trading is synonymous with Market Maker, a group or individual that creates a market in which a security can be bought and sold. This is not the only provider of liquidity and there can be other types of forex participants who provide liquidity to the market by increasing trading volumes.
These participants include central, commercial, and investment banks, multi-national corporations, hedge funds, foreign investment managers, retail forex brokers, high-net-worth individuals, currency futures market makers, high-volume active traders, and speculators.
A primary contributor to the high liquidity that the forex market is known for, is the market hours of the Over-The-Counter (OTC) spot forex market that is open 24 hours a day, 5 days a week. Different overlapping trading sessions start from Sydney or Australia open on a Sunday Afternoon until New York close on a Friday afternoon.
The high liquidity that the forex market is known for has an additional benefit other than ensuring that securities can be converted to cash quickly, these conditions also result in significantly reduced trading costs and fees.
This creates the perfect entry point for forex traders who have small investments amounts, given that they have a stable internet connection, a trading account, and a trading platform through which they can access the forex market.
The Role of Liquidity Providers in the Forex Market
A forex liquidity provider is either an institution or an individual that takes on the role of a market maker in the forex market. A market maker creates a market for the purchase/sale of a security, and they act as either the buyer or seller in a transaction, which means that they always take the opposite side of the trade.
The liquidity provider ensures greater price stability when they execute positions in currency pairs that can either offset with another market maker, or the transaction can be added to the order book of another market maker to be executed later.
Many forex market makers watch orders and the call levels of the clients whose trades they facilitate, poising themselves to execute market orders of these traders.
The largest and most prominent liquidity providers in the forex market are known as Tier 1 liquidity providers. This category includes large investment banks that have several forex departments to provide buy and sell quotes for all currency pairs.
These departments are also involved in providing CFD trading and they are known for providing the tightest spreads on currency pairs in which they have markets. Tier 1 liquidity providers, as primary market makers, trade positions to make money instead of solely relying on making money from the spread, providing these liquidity providers with several revenue streams.
Tier 2 liquidity providers include all other participants such as forex brokers. These market makers are willing to buy/sell forex pairs from/to clients if the market is open at the time of the transaction.
How online forex brokers provide liquidity to the retail market
Most individual retail traders will never gain direct access to Tier 1 liquidity providers unless they become extremely wealthy and can trade significant volumes. Instead, these traders are granted access to the forex market through an online broker or secondary liquidity provider who is then connected to a Tier 1 liquidity provider.
Many large, reputable brokerage firms use Tier 1 liquidity providers to fill most orders. These liquidity providers will only enter partnerships with brokers who are financially sound and reputable because it helps to alleviate counterparty risk.
For this reason, only highly reputable and well-regulated forex brokers have access to Tier 1 liquidity providers.
Different types of brokers employ different business and execution models, and the main types are Non-Dealing Desk and Dealing Desk brokers.
Non-Dealing Desk (NDD) brokers access either an Electronic Communications Network (ECN) or Straight-Through-Processing (STP) execution model or sometimes both, which means that transactions are routed directly to Tier 1 liquidity providers or a secondary provider.
Brokers who operate a Dealing Desk (DD) model are Market Maker brokers who are, subsequently, the liquidity provider that will have reserves of certain security. These brokers allow traders to buy and sell on their platform, with the broker taking the opposite side of the trade.
If traders want to buy a security, the Market Maker will be the seller and will set their price. If the trader wishes to sell a security, the Market Maker will set the price at which they are willing to buy back the security.
The price that Market Maker brokers charge is in the form of a fixed spread that includes the service or broker fee. However, there is a lot of controversy surrounding Market Makers as they benefit when traders lose money, meaning that they make a profit when they trade against their clients.
For this reason, it is crucial that forex traders only use the services of a well-regulated broker if they choose a market maker. Regulations will ensure that the broker offers a fair, transparent, and safe trading environment in which prices are not manipulated to constantly be in the favour of the broker.
Core Liquidity Provider
Core Liquidity Providers are financial institutions that act as intermediaries across several financial markets. The core provider buys large volumes of a certain security, or several securities, from the brokers who offer them.
The Core Liquidity Provider distributes these securities in batches to other financial institutions that offer these securities to retail traders, typically facilitated by ECN brokers. Core Liquidity Providers are typically banks or institutions that can finance and underwrite equity debt transactions which allows them to create a market or assist in the facilitation of trades.
Leverate
Leverate is a leading technology service provider with extensive experience spanning across all facets of brokerage management. Leverate is a large, influential force in the Fintech market with a position at the front line of developing and emerging broker technologies.
Leverate provides liquidity through LXCapital which aggregates liquidity from Tier 1 institutions to provide competitive rates in several financial markets.
Integral
Integral is a reputable company that develops and operates an FX Grid, a multi-sided trading technology connecting active market participants with a wide range of FX liquidity sources.
Integral offers liquidity across more than 100 financial instruments that are spread across several asset classes including major currency pairs, cross rates, exotic currency pairs, and precious metals.
Global Prime
Global Prime is a well-regulated and well-established forex and CFD broker in Australia that offers low latency connections to Tier 1 bank liquidity and a wide range of ECNs. Global Prime is involved in the building and provision of customized liquidity from regional banks, non-banks, and ECNs with proprietary algorithms.
FXCM Pro
FXCM is a leading broker that offers forex, CFDs, precious metals, equities, and cryptocurrencies. FXCM forms part of the Jefferies Financial Group and provides wholesale execution and liquidity solutions through FXCM Pro to hedge funds, retail brokers, and many other emerging market banks.
FXCM Pro has spent years forming and maintaining several strategic partnerships with Tier 1 banks along with other non-bank liquidity providers. There is a dedicated liquidity management team that sources efficient liquidity providers as well as partnering venues, allowing for full customization solutions according to its customer’s needs and objectives.
Swissquote Bank
Swissquote Bank is well-established, well-regulated, and reputable with several strong relationships with hundreds of financial institutions globally. These institutions are in the ideal position to reduce operating and trading costs while they increase trading volumes and revenue.
This is done by using tailormade services and Tier 1 liquidity solutions which are offered through Swissquote. Swissquote combines competitive pricing and innovative technology to offer its clients comprehensive packages that cater for their liquidity solutions.
X Open Hub
X Open Hub is a large and well-established Fintech broker that offers multi-asset liquidity and innovative trading technology. X Open Hub is also known for its open and transparent environment, providing institutional-grade liquidity on more than 3,000 financial instruments.
The multi-asset solutions provided by X Open Hub include several advanced capabilities, rich features, and comprehensive solutions that help clients maximize their product offerings.
B2Broker
B2Broker is a well-known liquidity and technology provider that offers solutions for both the forex and crypto industries. B2Broker offers some of the deepest liquidity pools across a wide range of financial markets.
B2Broker is also known for its Prime of Prime (PoP) services to different forex brokers, hedge funds, cryptocurrency funds, investment managers, professional traders, and several other financial institutions.
FAQ
What is liquidity?
Liquidity is the ability for a security, such as a currency pair, to be bought and sold quickly enough without this exchange rate or market price being affected.
Why is liquidity important?
Liquidity ensures fast trade execution that ensures low transaction and trading costs for both brokers as well as retail traders.
How do online forex brokers provide liquidity to the retail market?
By routing orders to Tier 1 and Tier 2 liquidity providers through different execution models such as ECN, DMA, and STP.
How do regulated liquidity providers make money?
They make money by taking the counter position in the trade instead of just relying on the bid/ask spread.
What types of liquidity providers are there?
There are Tier 1 liquidity providers which are big banks and institutions that buy assets from issuers while Tier 2 liquidity providers are brokers and smaller companies that facilitate trading to other retail brokers and traders.
Top 4 Brokers
