You may have heard that the forex market is extremely liquid compared to the stock market, but what does that mean? What does a high-quality liquidity provider do for a brokerage and its clients?
Let us find out.
Fundamentally the measure of liquidity of the forex market is the ease with which someone can buy or sell currencies. Over 5 trillion dollars are traded daily and therefore, the likelihood that someone is willing to buy what you are selling is high. That means trades are executed almost instantaneously, making transactions seemingly liquid, unlike stocks where a buyer has to wait for a seller to sell at the quoted price.
A liquid market makes it much more likely to be profitable. In an industry where decisions are often made quickly, brokerages need to facilitate rapid executions to appease their traders. Profitable traders need to be able to move in and out of positions at lightning speeds.
So, where does a brokerage get access to liquidity?
Simply put brokerages get liquidity from liquidity providers.
A liquidity provider is an institution working at both ends of the currency transaction, buying and selling currency pairs. They are a market maker if you will.
The U.S. Securities Exchange Commission defines a “market maker” as a company buying and selling currencies on a regular and continuous basis at a publicly quoted price.
Several entities provide liquidity they usually consist of massive institutions with specialist forex desks churning out currency quotes. They include national banks, investment banks, brokerages, private equity, and hedge funds. The best are regarded as tier one liquidity providers.
Retail traders cannot get access to a tier-one provider; instead, they participate in the market via a broker who has access to that specialist liquidity provider.
For a brokerage to be competitive, it is necessary to have relationships with many tier-one liquidity providers. That will ensure better spreads meaning lower fees for customers. Most Tier 1 liquidity providers have the tightest spreads and make money off trading activity, and do not just rely on the bid/offer spread to generate revenue.
How to Find a Liquidity Provider
When you are searching for a provider, you must assess the entire deal and analyze the terms of the liquidity being provided. The most critical factors being access to multi-asset liquidity and the FIX protocol, as well as historical data.
Some other essential features are market depth, and a liquidity provider must offer rapid executions with re-quotes or slippage, especially throughout volatile market events like news and NFP figures, etc.
All traders know that brokers have to be regulated, and liquidity providers must also be subject to the same strict standards. Being a regulated and licensed liquidity provider demonstrates to traders that the broker is a genuine STP/ECN broker, who will not manipulate trades against them. It is a matter of trust between your brokerage and your clients and trust is everything in this industry.
Popcorn technology, a London based fintech firm, has developed relationships with tier one providers. They also offer a white label brokerage platform that integrates seamlessly with payment providers and other third-party tools. They have an expert team waiting to help you out if you are thinking about starting a brokerage.