Liquidity Provider – How to select, choose and evaluate – Full guide

Contents

1. What does the liquidity provider?
2. Why Liquidity Provider is Important For Traders?
3. What aspect consider while selecting a liquidity provider?
4. What type of reporting packages should be provided by liquidity providers?
5. What are the types of connections with the liquidity provider?
6. How important for liquidity providers are execution and latency?
7. What characterizes the liquidity offer from X Open Hub?

What does the liquidity provider?

In a general sense, a liquidity provider connects customers with the institutions that issue an asset. Liquidity is a crucial idea in the market since it helps to keep costs down. Liquidity providers help with liquidity by keeping significant volumes of an asset, making it easily available for trade at a consistent price. For CFD liquidity providers, this is slightly different. In this case, the provider guarantees price feeds and the possibility of executing leveraged CFD orders. Brokers rely on liquidity providers to provide smooth trading conditions and asset availability.

Why Liquidity Provider is Important For Traders

When searching for a broker, seek one that has great liquidity. Brokers can accomplish this by forming strong partnerships with tier 2 liquidity providers or by working directly with banks or financial institutions.

• Instant trade: greater liquidity means faster execution of orders.
• Reduced slippage: If the processing time of an order is too long, the asset price may change before it is executed. Instant execution minimizes this risk.
• Stable prices: Choosing a broker with reputable liquidity partners generally means that prices will be attractive and stable, with no sudden changes.
• Lower Fees: Top liquidity providers with several agreements deliver extremely tight spreads and minimal costs.

Choosing a broker with renowned liquidity providers is a wise strategy to ensure you obtain the best possible pricing and spreads and that slippage is minimized.

What aspect consider while selecting a liquidity provider?

Choosing a Liquidity Provider (LP) is a demanding process, therefore a detailed analysis of pricing, economic efficiency, the effectiveness of the trading infrastructure, surveillance of the IT systems, legal aspects, and due diligence of the vendor should be conducted.

The following recommended list of qualification questions and considerations was created in order to help a broker to evaluate and choose the best possible liquidity provider.

The list should not be viewed as a complete list of points to be discussed, but rather as a framework for the most productive conversation possible when selecting the best LP.

Trustworthiness of the liquidity provider

Before choosing a Liquidity Provider a broker has to check if the LP is regulated. Also, the trustworthiness of the regulator should be verified. It’s advised to choose a public listed company as the LP. The broker will be able to check all the reports, financial stability, and condition of the potential partner.

If the broker is signing an agreement with a non-regulated LP, it’s advised to choose a recommended one, that is checked and verified by a reputable vendor.

Number of available instruments in the offer

Nowadays a multi-asset liquidity and deep order book is a must. The instrument list should cover FX (Forex), Commodities (Agriculture, Emission Rights, Energy, Industrial Metals), Cash Indices and Futures Indices, Bullions (Precious Metals including Gold, Silver, Platinum, Palladium), Bonds, Equities (Stocks, DMA, Synthetic Stocks, Equities CFDs with leverage), ETFs.

Liquidity Provider should present complete order book via trading platform and via FIX protocol, assuring access to the historical tick data of each level of the order book.

Execution

The execution offered by an LP should be fast (at least below 100 ms), without rejects or requotes. The reliable partner should also offer time priority execution and full post-trade transparency (MiFID compliant).

Last but not least, the execution system has to meet high standards, especially during market data releases and unexpected events such as SNB. The broker should be able to check execution using automated trading software, that allows him to build detailed statistics and searching for the opinions among current clients of a particular LP.

Pricing

Liquidity Providers should offer not only competitive spreads and commissions but also low overnight fees. Additionally, the broker has to make sure that futures-based instruments (commodities and indices) are not charged with swaps.

Today, only a few of the wide range of the well-known Liquidity Providers are offering their proprietary trading technology, which is trustworthy and well accepted by retail clients, but even fewer offer one technology and liquidity turnover fee.

Feeds

Liquidity providers should offer stable and reliable feeds without any spikes or gaps on the charts. Feeds should reflect prices from the interbank foreign exchange markets and underlying instruments from a list of stock exchanges. Retail clients and brokers should have the possibility to compare those prices in a convenient way. Access to historical market data and the tick data is an essential part of the solution as well as a complete order book presented via FIX protocol or trading terminal offered by the LP.

 Market data

A liquidity provider who’s quoting instruments based on the offer of certain exchanges is obliged to have signed a market data redistribution license agreement. Some of the best LPs have full packages of the market data ready to be implemented by their partners.

What type of reporting packages should be provided by the liquidity provider?

• Email reporting
• Full reconciliation reporting
• Closed and open trades reporting from the given period
• FIX bridge reporting
• Profitability reporting
• Swap points reporting
• Rollover reporting
• Hedging adequacy reporting

What are the types of connections with a liquidity provider?

The best liquidity providers have a full range of solutions ready to be implemented for their partners:

• FIX protocol connection
• API
• MT4 bridge and MT5 bridge connection
• MT4 Gateways
• Connections via reputable MT4 and MT5 bridge providers
• FIX protocol and M4 bridge or MT5 bridge installation

The most reputable liquidity providers very often have a set of FIX bridge providers already integrated into their trading environment.

Brokers can choose from the range of IT companies offering such products on the market. However, it can be beneficial for both counterparties to evaluate and select potential vendors together in order to make sure that all the points mentioned below were considered:

• Pricing
• Integration time and flexibility of the connection
• Reporting
• Stability and reliability of the integration
• Multiple LP connection options together with integrated BBO or iBBO model.

How important for liquidity providers are execution and latency?

For liquidity providers, the latency that matters is relative latency, defined as their ability to be faster than their peers. The aim is then to execute within the shortest time possible both in terms of detecting price discrepancy and in terms of execution. This has become the primary driver of the current arms race between liquidity providers (to beat their competitors). 

The most reputable liquidity providers have servers positioned in major data centers (e.g. LD4, FR5) near the biggest exchanges that deliver ultra-low latency & fast execution speed. Liquidity providers such as X Open Hub make money by processing orders. If there are no orders (order flow) routed to them, then they can’t make any money. As a result, liquidity providers compete against each other for order flow, and each financial institution chooses which LPs get which orders. 

What characterizes the liquidity offer from X Open Hub?

Our reliable trading technology and transparent liquidity fee structure ensure financial institutions achieve cost-optimized business models, increase profitability, and improve the efficiency of their operations. We offer deep institutional liquidity on 5000+ global instruments including forex, indices, commodities, shares, and ETFs, enabling Brokers and Banks to diversify their instruments portfolio. We are able to offer significantly improved spreads and much lower fees for retail brokers working in STP/ECN models.

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