Forex Market Liquidity

FOREX MARKET LIQUIDITY

With a daily turnover of several trillion USD, the Foreign Exchange market is one of the most liquid markets worldwide.

Why is Market Liquidity important for an asset class?

When there is plenty of liquidity, pricing becomes more competitive, and that shrinks trading costs, more specifically:

(i) Trading spreads are diminishing (shrinking trading costs) due to high liquidity

(ii) Market risk is reduced as large transactions can be executed without a major impact on the price of an asset

(iii) Other trading risks are also reduced (such as the credit risk)

(iv) The participation of institutional traders is facilitated, and that improves the long-term prospects of any market

(v) There are more opportunities for the introduction of new investment products such as ETFs

 

Liquidity providers in the Foreign Exchange market

 

Liquidity providers (LP) in the Forex market refer to those participants who buy and sell currencies on behalf of third parties. A Forex liquidity provider usually trades its own accounts, but at the same time makes some money by facilitating brokers to fill their clients’ orders. In the currency market, liquidity providers include banks, large financial brokers, and some investment firms.

When trading via the STP (Straight Through Processing) protocol, all trading orders are automatically transferred to liquidity providers. Overall, there are two types of liquidity providers: Tier-1 and Tier-2.

 

 

Classification of Liquidity Providers and the corresponding Forex Broker models (ECN, DMA, STP)

 

There are two levels of Forex liquidity providers:

 

(1) Tier-1 Liquidity Providers

Tier-1 liquidity providers mainly include vast international banks such as:

• Deutsche Bank, UBS, and Barclays Capital.

These three groups are the biggest liquidity providers in the Foreign Exchange market. All liquidity providers are electronically connected through the ECN (Electronic Communication Network).

However, there are also other categories of Tier-1 liquidity providers. For example, financial exchanges:

• CME Group, LIFFE, CBOE, ICE (Intercontinental Exchange), and Singapore International Monetary Exchange

Finally, some very large hedge funds, financial brokers, and investment firms are trading directly on the ECN network and can be classified as Tier-1 liquidity providers. Note that about 10% of all financial brokers can directly access Tier-1 liquidity.

• Forex brokers that can directly trade Tier-1 liquidity are called ECN Forex Brokers

• Forex brokers that can directly connect to a large Tier-1 liquidity provider are called DMA (Direct Market Access) brokers

 

(2) Tier-2 Liquidity Providers

Tier-2 liquidity providers refer to financial entities that act as middlemen between Tier-1 institutions and financial brokers. These are some key Tier-2 liquidity providers in the Foreign Exchange market:

• Currenex, LMAX Exchange, Integral, FXCM Pro, and Swissquote

The clients of Tier-2 liquidity providers are Forex brokers that do not have large enough volumes to connect with Tier-1 providers.

• Forex brokers that access Tier-2 liquidity are called STP Forex Brokers (Straight Through Processing)

» Compare Forex Brokers and Trading Conditions

List of Liquidity Providers

The following table presents the largest liquidity providers worldwide.

Table: Major Global Liquidity Providers

UNITED STATES	CME Group	Morgan Stanley	Citi Group	CBOE Global Markets	JPMorgan	Equinix	Currenex
	Goldman Sachs	Merrill Lynch	Nasdaq	Bank of America	FXSpotStream	Tradepoint Systems	EasyFX
	NYSE	ICE	Nadex	FXDD	GAIN Capital	Seabury Global Markets	TradAir
	Edgewater Markets	FTPrime
	Spotex	Jefferies	Calypso Technology	Global Trading Systems	BNY Mellon	oneZero Financial Systems	Forexware
EUROPE (EU)	Euronext	Deutsche Bank	ABN AMRO Clearing	Flow Traders	Luxembourg Stock Exchange		Societe Generale
	BNP Paribas	TopFx
UNITED KINGDOM	Barclays Capital	UK Clearing House	Make Capital	TP ICAP	Finalto(Formerly as TradeTech Group)	IXO Prime	LMAX
	Refinitiv	iS Prime	CrescoFX	CMC Markets	Rayfin Solutions	DMALINK	CrescoFX
	FXCM Pro	Quod Financial	GMEX GROUP	Sucden Financial	FX Connect	Standard Chartered	London Stock Exchange
	XTX Markets	Tickmill Prime
SWITZERLAND	UBS	Credit Suisse	BierbaumPro	Swissquote	SIX Swiss Exchange(SIX)
JAPAN	Nomura	MUFG	Mizuho Bank	Tokyo Stock Exchange(TSE)
HONG KONG	Global eSolutions	HSBC	m-FINANCE	Hong Kong Stock Exchange(HKEX)
SINGAPORE	Spark Systems	Saxo Group	Singapore Exchange
AUSTRALIA	The National Australia Bank (NAB)	26 Degrees	ACY Securities	BAXTER-FX	Macquarie
CANADA	CIBC	Ticktrade	RBC Capital Markets
SAUDI ARABIA	Saudi Stock Exchange (Tadawul)
BELIZE	ARVIS.FX

 

How retail trading orders are transferred to liquidity providers?

This is the simple process that connects retail traders and liquidity providers:

(i) A retail trader places a market order on the trading platform of a retail broker

(ii) The broker automatically passes this order to a liquidity provider by charging the trader a commission based on the volume of the transaction ($/lot)

(iii) The liquidity provider executes the order on the market. The broker is charged with a commission based on the volume ($/lot)

 

 

Market Depth

 

Market liquidity is directly associated with the depth of the market.

What is Market Depth?

Market depth measures how much liquidity is available at various prices. It shows the aggregate volume of buy/sell pending orders at each price level. Note that pending orders are executed if the market reaches a specific price level.

Market depth highlights the ability of buyers and sellers to execute large market orders without significantly impacting the price of the asset.

The market depth is determined by:

• The number of buyers and sellers who are frequently placing orders and making transactions

• The size of buyers and sellers who are frequently making transactions

• The participation of institutional traders and market makers

The more participants in the market, and the larger their size, the greater the market depth and the market liquidity.

 

Key Takeaways

 

• Market liquidity is very important as it makes pricing more competitive and reduces trading costs. In the currency market, liquidity providers include banks, large financial brokers, and investment firms

• There are two levels of Forex liquidity providers, Tier-1 and Tier-2. According to the access that they have to Tier liquidity, Forex brokers are classified as ECN, DMA, and STP

• Dealing-Desk (DD) firms are not classified as Forex brokers, as they create their own market without passing their clients' orders to Tier-1/Tier-2 liquidity providers

• The key liquidity figure is trading volume. High trading volumes indicate an active market with high liquidity

• Market liquidity is associated with the depth of the market. The depth of the market refers to the ability to execute large market orders without significantly impacting the price of the asset

• High liquidity reduces market risks. Studies have shown that the lack of liquidity is associated with financial crisis

 

■ Forex Market Liquidity and Liquidity Providers (LPs)

G.P. for CarryTrader.com (c)