Being a trader, have you ever wondered when you buy or sell who is on the other side of your trade?
When you sell who buys it or when you buy who actually sells it.
If you trade with an A Book Broker, there is good possibility that there is an external third party called Liquidity Provider that takes opposite side of you trades and fill your orders.
In this blog, we will dicuss about the Liquidity Providers and how they operate, how they make money etc.
Lets get started!
Who are Liquidity Providers?
Liquidity providers are the brokers of brokers!
They are the individuals or businesses that take the opposite side of trade in any given security, instrument or symbol like forex, crypto, CFDs, Stocks etc.
When a trader places a Buy or Sell order in specified quantity and price for a security like forex, crypto, stock, etc. Liquidity Providers voluntarily take the opposite side of the trades. So technically traders are trading against liquidity providers and vice versa.
If you are planning to start a forex brokerage business, understanding the FX Liquidity Providers and their way of doing business will help you a lot. When you are finalizing the Forex White Label like MT4 White Label, MT5 White Label etc, selecting an appropriate Forex Liquidity Provider is one must too.
Liquidity Providers in Forex are the most important business partners that help a forex broker stay liquid and allow traders to enter and exit the trades without any issues.
Liquidity Providers don’t see individual traders’ trade rather they just see all the trades as if they were placed by broker itself. Technically, your Forex or Crypto Broker is a client or trader for Liquidity Provider.
All the trades sent to them is considered to be placed by one client only i.e, broker.
What Is Liquidity In Forex, Crypto Markets?
Here is the simplest definition of Liquidity in Forex, Crypto Markets; ease of entering into a trade and exiting at the price you want is Liquidity for any market be it Forex, Crypto, Stocks, CFDs or Derivatives.
Higher liquidity means lower slippage and vice versa thereby lower cost of trading for traders.
So if you are a forex or crypto trader, you must look for brokers or trading platforms that provide high liquidity in your choice of pairs and symbols.
Why Does A Liquidity Provider Take Opposite Side Of Every Trade?
A liquidity provider takes opposite side of trade and the risks that comes with it because that’s their business!
There are several ways they make money by providing liquidity but the most common is following:
Liquidity Providers supply with liquidity and in return they earn profits when traders lose money. A rough estimate says that over 70-95% traders in stocks, CFDs, Forex & Cryptos lose money.
And where does that money go? It obviously goes to the party who took the opposite side of trade. Hope now it makes perfect sense to you Why does a Liquidity Provider take opposite side of every trade?
Types Of Forex Liquidity Providers
When it comes to Forex Liquidity Providers, they can be categorized into:
Tier 1 Forex Liquidity Providers
If we look at the structure of the Forex Market, the world’s largest investment banks and hedge funds are positioned at the top who own and control the largest pool of FOREX. These banks are the Tier 1 Forex Liquidity Providers for Forex Market. Here is the list of some Tier 1 Forex Liquidity Providers:
- Deutsche Bank
- Commerzbank AG
- BOfA Merrill Lynch
- BNP Paribas
- Effex capital
- Royal Bank of Scotland
- Morgan Stanley
- Goldman Sachs
- Societe Generale
- Credit Suisse
- Royal Bank of Canada (RBC)
How do Tier 1 Forex Liquidity Providers make money?
Tier 1 Forex Liquidity Providers primarily make money by:
- Charging Spread which is the difference between the bid and ask prices for a symbol.
- Charging Commission on Trades (Buy – Sell)
They only deal with prime brokers other banks, large corporate and institutions. The volumes are so humongous that despite charging in fraction, they make huge amount of money.
Tier 2 Forex Liquidity Providers
They operate at inter bank stage and directly deal with all kind of Forex Brokers depending on their own criteria. They are called market makers interchangeably as they provide the buy sell prices for a security thereby making the market.
Market Making is a legit business and regulated by appropriate authorities in different countries and zones.
How do Tier 2 Forex Liquidity Providers make money?
Tier 2 Liquidity Providers make money in almost all possible ways mentioned below.
How Do Liquidity Providers Make Money?
Spread in forex means the difference between buy and sell price of a currency pair where a trader may place order. Swap is the mark up added by Liquidity Providers on the raw price quotes.
Liquidity Providers charge a small spread on bid and ask prices they quote for a currency pair or symbol.
This spread is usually very low as they are dealing into large volumes. There are several forex and crypto brokers associated with them who send their clients orders to the LP everyday.
Now you can imagine the volume and earnings made by LPs.
The other critical thing to note here is that brokers too charge Spread on top of quote they get from LPs. So LPs must charge lower spread.
Swap Charges are levied on trades carried over for the next day by LPs & Brokers. Its optional and some LPs & brokers may not charge it to large account holders.
Every time a position or trade in a currency pair is not closed within same day and carried over to the next trading day, Forex Liquidity Providers charge small fee called Swap Charges.
Swap Charge is another significant contributor to the revenue of Liquidity Providers as most of positional or swing trades last for more than couple of days and weeks.
Most of LPs charges SWAP but few may not charge it. Its completely on their business model.
Taking Opposite Side of Trade
FX Liquidity Providers are into the business of taking opposite side of trades. They take the risk of losing money in hope that the traders would loose more which will be earnings of LPs.
Trading is a zero-sum game which means one party loss is another’s gain. Now here is another fact; over 95% of retail traders lose money trading forex, CFDs and crypto.
Most of what is lost by traders goes to LPs. This contributes largest part of their revenue.
Hedging is an age old process of risk management in securities market wherein risk of one trading position is hedged in same or other security by taking other position which is usually opposite in nature.
LPs may hedge the position against your trade into same or some other instruments if they are skeptic of losing money or it has better probability of profits to employ the money into some other instrument.
Brokers usually deposit a decent sum as security money to open an account with a Liquidity Provider.
And when a trader opens a position, Margin used in this trade goes to LPs account.
Earnings on Treasury Money
Liquidity Providers get constant flow of money which they need to settle in scattered fashion similar to insurance business where you get deposits by way of premium and payout money in claim.
These all monies create a Treasury at LPs end which they are free to employ to other means of earnings.
They make money by using traders money to Lend it to banks, businesses, government agencies or to whoever is interested and can afford the interest.
Hope this article brought the greater clarity on Who is Liquidity Providers, their types & how they make money.
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