In practical terms, a Liquidity Provider (LP) in the FX Industry is a company that streams prices through a bridge into a FX Broker’s online trading platform and takes the other side of the FX Brokers client’s trades. While a FX Broker is typically a Business to Consumer (B2C) company, a Liquidity Provider is usually a Business to Business (B2B) company. But what does that really mean? Aside from small differences in technical functionality, how is a Liquidity Provider really different from a FX Broker?
Answer: Liquidity Providers are essentially operating the same type of business as FX Brokers. They both have to decide what spread, commission, and slippage they will provide to their clients, and they both have to decide whether to take risk or to pass it on.
Understanding the concept of “taking risk” on a trade order is critical to your success as a FX broker. If your Liquidity Provider is taking the other side of your client’s trade orders and not passing them on to another Liquidity Provider, then your Liquidity Provider is taking 100% of the risk associated with your client’s trade orders. Simply put, if your clients make money on their trades, then your Liquidity Provider will lose money, and vice versa. Your Liquidity Provider making money as your clients lose money is clearly a conflict of interest. In this situation, your Liquidity Provider has incentive to make your clients lose money. This is bad for the obvious reasons.
Almost every Liquidity Provider in the industry will tell you that they a-book/STP/pass on trade orders to another Liquidity Provider, or to the “Big Banks.” Most of them are lying. The vast majority of Liquidity Providers take risk, even though they won’t admit it. Maybe they don’t take 100% risk on their incoming flow, but they almost certainly will take some risk. There are a few exceptions in the industry, but they are exactly that – exceptions. So how do you tell if your Liquidity Provider is b-booking/taking risk on your client’s trade orders that you send to them? One obvious “tell” is to take a careful look at the spread and commission. If, for example, their spread on EURUSD is 0.1-0.3 and they don’t charge any commission, then you know for sure they are b-booking, because if they simply passed on the flow to another Liquidity Provider or tier-1 bank they would be losing money on every single trade. If your Liquidity Provider’s spread on EURUSD is 0.1-0.3 and they charge $15-$20/per million, then there’s plenty of room for your Liquidity Provider to be paying the full cost of passing on the trade to another Liquidity Provider or bank and also to be making money on every trade. In the rare instance that your Liquidity Provider is connected directly to a Tier 1 bank, their cost to pass flow on is usually the spread (0.1-0.3 on EURUSD) plus $4.50 – $6.00 per million in commission. That’s why as a broker, you should never be paying more than $15-$20 per million in commission to your LP. Most Liquidity Providers will give FX Brokers a tiered system of per million fees based on the volume that you send them. Liquidity Providers that are actually a-booking will never go lower than $8.00 per million because then they won’t be making any money on the flow.
Another tell-tale sign that your Liquidity Provider is b-booking your trade orders is if they say that “they are connected to the Big Banks.” If you hear the words “Big Banks” it should be a huge red flag/warning to you that the person you’re speaking with is dishonest.