Liquidity Providers and ‘HFT’ Order Flow

Computer technology has changed the way financial assets are traded nowadays. The handling of huge numbers of orders without even small human action, whereby very sophisticated computer algorithms automatically make multi-trading decisions, submit orders, and close positions, has become ingrained in the FX market.

Two sides of the same coin  – High frequent Trading  Regulations

Heads of trading brokerages, having seen HFT and algo trading go through the roof, have started to clamp down on excessive orders and to cancel the most abusive ones.

The prime brokers have begun to encourage ‘good’ liquidity, i.e. those partners with good fill ratios, and punish the ‘bad’.

Legal regulators also took note of this trend and introduced new regulations

MiFID II is a set of direct market access limits and algorithm disclosure requirements for HFT firms. In Europe, MiFID II rules are expected to come into force in January 2018.

On the other hand, high-frequency traders can argue that they are actually doing the forex industry a favour by keeping liquidity propped up.

They claim that they are making sure customers can buy and sell when they want to. They state that they are providing much-needed liquidity, or the ability to trade without affecting prices on the market. They want to be seen as reliable counterparties who use sophisticated technology to offer tight prices in even the most unpredictable market conditions.

A combination of economic incentives and controls makes this happen. The exchanges must monitor their market makers in real time to make sure that they are living up to their quoting obligations.

Forex brokers are also taking greater initiative. You can see innovative FX brokers taking measures to rein in unproductive ‘toxic flow’. Brokers are increasingly resorting to tactics that discourage excessive orders ‒ but in a very different way.

It may look as if FX brokers are acting as exchanges and taking action to control toxic order flow through their pricing strategies.

Role of liquidity providers

Brokerage owners need to perceive every opportunity and threat hidden in their clients’ flow patterns and automate their own real-time responses in order to stay profitable as markets change.

There are ways in which liquidity providers can help brokerage owners.

Providers could offer extremely flexible liquidity solutions that enable them to start their operations with insignificant volumes and, over time, grow into businesses requiring high-volume transactions.

B-book brokerages are less dependent on sources of liquidity as long as the feed is clean and reliable.

It is common for FX providers ensuring market access to their clients to react to predatory algorithms and fluctuating fill ratios. Traditional customer profiling based on purely historical data is good for strategic decision-making.

However, for more tactical decisions with immediate impact, real-time analysis is additionally required.

In this case, the X Open Hub liquidity provider can help, by:

  • mitigating ‘toxic flow’, by monitoring predatory patterns in real time;
  • increasing business, by detecting reductions in flow from ‘good’ clients and automatically reducing spreads for those clients;
  • preserving client relationships, by detecting pending credit breaches and immediately calling the client.

X open Hub’s liquidity solution

Clients of X Open Hub can use the xRisk platform to perform their own customer flow analyses.

Key parameters include P&L on individual trades, an aggregated view of individual trades over time, and the performance of client groups.

By using real-time customer flow analysis, brokers can figure out which customers are providing the types of order flow that they need.

Customer flow fits alongside other real-time market trend analytics such as volatility, average daily volume, and book depth.

For example, flow from a specific customer is high but liquidity is thin; in such a case, in addition to customer behaviour, the time of day impacts spreads. Our customers have also been generating pricing dynamically – adjusting spreads and skews – based on market conditions and customer trading patterns, including HFT patterns.

Dynamic pricing builds on an aggregated order book as source pricing. A basic pricing service dynamically applies a set spread to the base price generated from the aggregated book. A more advanced service changes the spread based on any data or rule, for example:

  • current volatility
  • book depth (volume on both bid and ask sides)
  • real-time risk parameters such as profit/loss levels
  • news
  • current vs target position (changes the spread or skew automatically and updates the auto-hedger service)
  • customer tier
  • historical and real-time customer trading behavior

Brokers can incorporate input, including aggregated FX prices, customer trading patterns, market volatility, and hedging activity – all in real time.

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