How to Maximize Profits with Ultra-Tight Spreads

Contents

1. Hedging and Tight Spreads
2. Tighter Spreads and Customer Retention
3. Challenges Brokers Face in Offering Tight Spreads
4. How Professional Liquidity Provider might help to avoid slippage issues
5. What to Look for in a Liquidity Provider?
6. The Bottom Line

Did you know liquidity across the US financial markets hit rock bottom after the debt ceiling deal in May 2023? The anticipated consequence of the banking crisis has shaken investor confidence globally. So much so that even the Bitcoin market lost liquidity to levels worse than after the FTX collapse.

This can be a difficult time for brokerages because loss of liquidity leads to market inefficiencies, increased slippage and thin order books. These conditions make even the most experienced traders stay away from the market. If trader activity declines, it is bound to affect revenues for your brokerage.

The ray of hope in these turbulent times is that retail traders are sitting on a cash pile of almost $1.8 trillion. This is a result of rage selling, driven by recessionary fears in 2022. Now that recessionary fears appear to be on the decline and the massive trading firepower that retail investors have, individual trading and hedging is expected to drive the markets in 2023. Moonfare’s investor survey suggests that amid economic instability, defensive strategies could play a major role in shaping trading decisions. Therefore, traders are expected to rely more on hedging and effectively diversifying their portfolios to maintain profitability and mitigate risks.

Hedging and Tight Spreads

Participating in the financial markets is inherently risky. The risks increase when there is fear of slippage due to lack of liquidity. Plus, costs rise when low liquidity leads to wider spreads. This is especially experienced by traders of minor or exotic forex pairs. The problem is that steady liquidity with low forex spreads is mostly accessible to institutional investors with access to institutional-grade liquidity. For the retail segment, such low spreads are available only for a limited time when the forex sessions of the top global markets overlap.

Market fluctuations, unexpected news, unfavourable economic data and internal updates from a country can result in price gapping as a currency (or a pair) becomes less liquid. This can lead to dissatisfying experiences, leading to your clients losing enthusiasm. Moreover, the OTC markets present a wide range of bid-ask rates, while slippage throws spreads and traders’ strategies off-balance.

Ultra-low spreads facilitate hedging at lower cost, reducing the magnitude of potential losses. Additionally, tight spreads reduce the risk of margin calls or stopping out of hedging positions. Further, low spreads might just motivate your clients to make the most of more market opportunities. In other words, improved hedging experiences enhance activity on your brokerage platform, which boosts your revenues.

More experienced market participants tend to seek ultra-thin, and sometimes variable, spreads. This is because variable forex spreads can at times be tighter than fixed ones. On the other hand, there are times when traders are unable to open too many positions or get high execution speed with lower spreads.

Also, tighter spreads are critical for certain strategies, such as scalping and other high-frequency techniques. With the tightest spreads, some traders might feel more comfortable using algorithmic and robo trading. A brokerage may stand to lose a significant customer base if it is unable to facilitate fast-paced strategies due to wider spreads.

Tighter Spreads and Customer Retention 

Did you know that acquiring a new customer can cost almost 7 times the expense of retaining an existing one? Plus, long-term customers become your unpaid brand ambassadors, who help acquire new ones! So, it is a win-win for a brokerage to provide existing customers best-in-class facilities.

Providing bespoke spreads across a wide range of financial instruments can give your brokerage an edge over the competition. Additionally, it disseminates the message that you have access to deep liquidity, which in turn helps improve customer acquisition.

Challenges Brokers Face in Offering Tight Spreads 

Offering competitive spreads can be a differentiator in the intensely competitive financial markets. But collaborating with multiple institutions to facilitate deep liquidity is tedious. This is because many liquidity providers do not offer the same level of liquidity across a wide range of financial instruments or jurisdictions. Also, partnering with several institutions could add to your operational costs, which may end up turning traders off if you pass on the expenses to them.

Therefore, partnering with an experienced global liquidity partner is essential. Leveraging the expertise and experience of a trusted partner can allow you to focus more on value-added service provision, such as improving the customer experience and providing financial education to empower your clients. 

How Professional Liquidity Provider might help to avoid slippage issues

Experiencing slippage issues? They can lead to lower profits and bigger losses. Luckily, professional liquidity providers wield a toolkit designed to tackle these challenges:

Deep Order Book available via FIX 4.3 or FIX 4.4: Thanks to FIX 4.3/4.4 integrations that allow full order book presentation, these providers ensure exact information about market conditions. This feature allows clients to assess the performance of each LP. Clients are able to choose the provided with deepest order books and most effective execution. What does it mean for you? A reduced risk of slippage and smoother trading experience.

Order Book-Based Execution: No more limitations due to time priority order execution. By executing orders based on a full view of the order book, you can gain greater precision and better fills, effectively curbing slippage and optimizing your trades.

Full Post-Trade Reporting: In-depth reporting for a better understanding of your trade executions. Spot slippage patterns and devise strategies to reduce them. Your trading just became a lot more transparent and efficient.

Ultra-Fast Price Feeds: Access the most accurate, current market data thanks to ultra-fast price feeds sourced directly from exchanges and top-tier banks. Minimize discrepancies that could lead to slippage and make more informed decisions faster.

Servers: It is highly important to have servers hosted in top-tier data centres worldwide. You can trust in the reliability and speed of your operations, regardless of where you are. These centres offer reduced latency for faster transactions and robust security measures for reliable uptime. So, whether you’re trading from London to Hong Kong, you’re assured of fast and efficient execution. Our recommendations: Equinix and Digital Reality.

Maximum order size and maximum NOP (Net Open Position).

Two additional aspects that brokers should consider when selecting a Liquidity Provider (LP) are NOP Limits and Maximum Order Size.

NOP Limits are vital for brokers who hedge their net exposures. They must be aware of these limits on the LP side; otherwise, some orders might be rejected and the additional exposure might not be accepted. Every LP maintains different policies regarding NOP, so it’s advisable for brokers to consult with their LP on this matter before signing any agreement.

The second point is maximum order size. Liquidity providers should not artificially limit the maximum order sizes. The maximum order size should always be the result of the available tickets in the order book. It allows the clients to effectively hedge their exposures.

TRUST

Trust, although less quantifiable, plays a crucial role, particularly in contentious situations. In any business, unclear situations arise that require goodwill from one party to settle claims. Working with an LP where the broker personally knows the decision-makers can simplify problem-solving compared to larger, structured organizations with strict procedures and policies. Personal connections can often expedite resolutions in these scenarios.

What to Look for in a Liquidity Provider?

During economically turbulent times, many investors tend to resort to shorting. But shorting requires deep liquidity for ultra-fast execution. Slippage might defeat the entire purpose of shorting.

To ensure that as a broker, you are equipped to offer best-in-industry forex spreads, look for the following in your liquidity partner:

• Access to institutional-grade liquidity across geographies.
• Multi-asset liquidity, for forex, stocks, indices, commodities, cryptocurrencies, ETFs and CFDs.
• Licensed by regulators from various jurisdictions, including the FCA, CySec, KNF, IFSC, DFSA and FSCA.
• Strong track record of partnerships across different countries.
• $0 volume commission on OTC instruments to drive activity.
• Transparent order book management to build customer trust.
• Rich tick data directly from exchanges with historical data for reference to bolster customer confidence.
• To maximise your outreach, look for multi-connectivity using global standards, such as FIX 4.3 and 4.4, xAPI, MT4/ MT5, and an array of gateways and bridges.

The Bottom Line

X Open Hub is a liquidity provider for over 5,000+ instruments, including 2,000+ stocks and ETFs on 16 major exchanges across the world, 60+ currency pairs, 20+ cryptocurrencies on 9 exchanges, 20+ indices and the most popular commodities. We are proud to have forged and sustained 100+ partnerships across more than 25 countries. Capitalise on our global network to maximise liquidity and enhance your product offerings. When you partner with X Open Hub, you can offer customers the best possible market depth, execution speeds and pricing with ultra-tight spreads.