Things to Consider When Choosing a Liquidity Provider
September 7, 2016
Starting a forex brokerage is a complex process that should take into consideration many factors in order to find out the right positioning when it comes to competitor’s offer. Out of all the things to consider, though, the most difficult is to choose a liquidity provider.
This is valid from a trader’s point of view as well as it is facing the same question when choosing the broker to trade with, as execution will be different depending on the liquidity provider/providers the broker is working with.
Market Makers vs. STP
Brokers are divided into two big categories: dealing desks and no dealing desks. The brokers in the first category are also called market makers and the reason for that is the fact that these brokers literally create a market for their traders, quoting bid and ask prices as close to the interbank market as possible.
The no dealing desks brokers can further be subdivided into ECN (Electronic Communication Network) and STP (Straight Through Processing), brokers.
There are very few true ECN brokers and it seems that the vast majority are STP. To fully understand what STP means, imagine that these brokers still don’t have access to the interbank market, but will quote their orders based on the liquidity provider’s quotations from the interbank market.
These quotations (or prices) are different from a liquidity provider to another, some offering better prices than others.
For example, if a broker works with four liquidity providers then for the EUR/USD or any other currency pair for that matter, will have four different bid and ask prices, from the worst ones to the best ones. The broker chooses then the best price, ads a markup (this gives the spread) and then shows the quotation that the forex trader is actually seeing.
What Matters for the Forex Trader?
A very good question would be why does the forex trader care what type of a broker is dealing with and why liquidity providers matter?
What the forex trader really sees is a small spread due to the five digit accounts that can be offered with the STP technology and doesn’t really care what’s behind the quotations that are blinking on the trading platform.
But the thing is that these quotations are different from broker to broker and the more stable and exact are, the better. This can happen only if the broker works with the best liquidity providers that can get the best prices from the interbank market.
In the case of a market maker, the broker is matching the trader’s order by virtually going in the opposite direction. This may seem like a conflict of interest but in reality, a broker will always strive to have active traders and not to scam them. These brokers take the opposite side of a trader’s order only when the order cannot be matched with the ones from its liquidity provider.
As it can be seen, liquidity providers are key in the trading process and they are very important to both traders and brokers. Access to the best liquidity provider is one of the main things that differentiate good brokers from excellent ones, and traders should appreciate this when considering opening a trading account with a forex broker.