A liquidity provider is an individual or institution which acts as a market maker in a given asset class. This means that the liquidity provider will act as both the buyer and seller of a particular asset, thus making a market. For example, many stock exchanges have liquidity providers who make the responsibility to provide liquidity in a given equity. These liquidity providers make the commitment to provide liquidity hoping that they will be able to make a profit on the bid-ask spread.Liquidity providers ensures that prices are stable and also enhance liquidity by making it easy for traders to buy and sell at any price level.
HOW FOREX BROKERS PROVIDE LIQUIDITY TO THE TRADING MARKET
An individual trader, unless they are extremely wealthy and trade in large amounts, will never get direct access to a Tier 1 liquidity provider. Alternatively, their access to the forex market will be provided by a broker or a secondary liquidity provider like a small bank or payments company.Reputable forex brokers typically use at least some Tier 1 liquidity providers to fill most of their orders. These types of institutions only enter into relationships with providers that are financially sound to help reduce their counterparty risk.
Online forex brokers typically access an ECN and STP network to execute their trades. ECN stands for Electronic Communications Network, while STP stands for Straight through Processing. Other brokers operate on a No Dealing Desk basis, meaning that all their transactions go directly to a Tier 1 or secondary liquidity provider.Brokers that operate a dealing desk take on the role of a liquidity provider by allowing their clients to buy and sell on their system with the broker laying off excessive risk with professional counterparties as deemed necessary. These firms effectively act as market makers and their business takes advantage of the fact that the majority of traders lose money when they trade.
Forex brokers connect with more than one liquidity provider to enhance their dealing rates and spreads. By combining different liquidity providers, the broker can offer their customers the best price obtainable from several liquidity providers.Forex brokers usually create electronic bridges to automatically connect their own or a third party trading platform with another platform that acts as an ECN. These bridges are set up so that when the broker is connected to the ECN, they can choose which orders or groups of clients have access to be processed by the ECN where those transactions are automatically covered, while orders from non-preferential clients may not be covered.This is a situation where the broker passes through some transactions, while taking the other side of customer’s trade.
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