Liquidity when creating a broker: precautions you must take

 

Liquidity when creating a broker is one of the fundamental pillars in the Forex market, without it, a Broker Startup would not be able to provide its services. That is why it is very important to hire a provider with good liquidity that guarantees the best service.

Liquidity in a market is very important, there are researches that show that financial crises are closely related to the lack of liquidity. But you may wonder what aspects should I take into account when hiring a liquidity provider?

In this article, you will learn about the initial precautions to take when selecting any provider.

What will you learn in this article?

1. Which entities make up liquidity?
2. Liquidity for A-book and B-book brokers
3. The notational liquidity fee
4. The raw liquidity spread
5. Liquidity problems
6. Requirements of a liquidity provider
7. Recommendations

Which entities make up liquidity?

Liquidity in Forex is obtained from liquidity providers. These can be large institutions, large hedge funds or even large brokers acting as a market.

Examples of liquidity providers:

• Central banks
• Investment banks
• Hedge funds
• Broker
• Individuals with a lot of capital

Liquidity when creating an A-book and B-book Broker

A-Book Brokers:

• They send their clients’ orders to liquidity providers.
• They make money on the spread or notational commission. (more on this later).

In this case, there is no conflict of interest because the brokers do not have their clients’ money in their possession, but it is in the liquidity. So the Broker receives the same benefits regardless of whether their clients lose or win their trades. This generates greater confidence for their clients because there are no interests involved. They are also called STP Brokers.

B-Book Brokers: These brokers keep the invested capital of the clients internally and work in counterpart to their clients, which means that the profits of these operators are equal to the losses of their clients. This type of business is very profitable for brokers.

Also called Broker market makers

Notational commission of liquidity when creating a broker:

Obviously, as in any business, liquidity providers must make a profit, since they are the market and do not intervene in the losses or gains of the investments, they simply act as the market. So where do they make the profits?

Liquidity charges X notational per lot. Let’s go step by step…

What does notational mean?

Notational means the value of the base currency. For example, if we refer to the EUR/USD pair, it means that liquidity will charge you X euros per lot. If we talk about the USD/JPY pair, the liquidity will charge you X dollars per lot.

Well, now let’s see how it charges: liquidity charges the Broker, and in turn the Broker charges the client as something already inherent, for each lot placed in the market (when the trade is opened) and for each lot taken out of the market (when the trade is closed).

Let’s give an example: if you open a trade of 1 lot in EUR/USD, i.e. a trade of 1,000 euros, the liquidity will charge the broker X euros and when the trade is closed, the liquidity will charge the broker X euros.

Liquidity sets the raw spread

This spread is the one imposed by the liquidity provider as raw, as a minimum. For example; an International Raw Spread in the EUR/USD is usually around 0.1 pip. Then the broker increases this raw spread to obtain its profits.

Liquidity problems when creating a Broker

To avoid further damage to your business it is important that you know the main problems that you could face if you do not handle well the issue of a liquidity provider when creating a Broker. Although in the first place it may seem that the most important part is to hire the liquidity provider with the lowest notational commission, this has a low economic impact on the Broker’s economy.

The most relevant factor when contracting liquidity is its reliability, i.e. that the liquidity is stable. It is essential that there are no problems in admitting and handling large volume operations, and that there are no important “slippages” or “gaps” beyond those of the market in general.

This factor is of great importance because this is where the Broker can lose many clients due to liquidity problems since if the trader has problems with his trading he will attribute them to the Broker and not to the liquidity that the Broker has decided to hire.

The loss of clients is a much bigger problem than the small savings in the difference in the notational fee between different liquidity providers.

Another aspect to keep in mind is that some liquidity providers usually set a mandatory minimum of monthly lots (very high for a startup), and when these figures cannot be reached, a commission is charged, which is not at all profitable.

Conclusion: Liquidity when creating a broker

It is important not to be guided by the notational price of liquidity, which at first seems cheaper, but in the long run, the cost of losing customers is something that will severely affect your business.