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Meaning and Importance of Forex Liquidity

Forex Market

Forex liquidity is the ability of the forex pair to be purchased and sold without impacting its exchange rate. A forex pair tends to have high liquidity if it can be bought and sold conveniently, and there is a considerable amount of trading activity for that currency pair. There is a lot of significance of liquidity in the forex market as it is the liquidity only that can make any trade profitable. A high level of liquidity leads to an easier flow of transactions and makes pricing much more competitive. Hence, the provision of forex liquidity is vital for the proper functioning of the forex market.

Who Provides Liquidity In The Forex Market?

In forex trading, a liquidity provider refers to a market maker or an institution working as a professional market maker to execute currency transactions. You can find various types of market players who offer liquidity in the forex market, which leads to an increase in the forex liquidity volume. Some of them are major commercial banks, central banks, hedge funds, forex brokers, retail traders, foreign investment managers and individuals with high net worth. The topmost liquidity providers in the forex market are known as Tier 1 liquidity providers. They are the large investment banks with big forex departments that offer buy/sell quotes for the currency pairs.

The Significance Of Liquidity In Forex:

Traders should never get stressed when it comes to forex liquidity. You must already know the presence of a liquid market is vital to attract excellent rewards in trading. This is the reason for the popularity of liquidity service providers. A liquidity provider helps traders achieve better price stability by taking a significant position in forex pairs that could be offset with other market makers or added to the market maker to be liquidated later on. Many market makers supervise orders and call levels for their clients and execute clients’ orders on their behalf. 

Liquidity Forex

However, one thing you should keep in mind is that individual traders can’t access the Tier 1 liquidity providers directly. They need to access an online forex broker for the same. You can find several reputable forex brokers in the market who use some of the best Tier 1 liquidity providers to fill most of their market orders. Furthermore, they generally provide access to the ECN/STP network for the execution of trades. Also, there are some brokers who operate on an NDD (no dealing desk) basis, which means that all the transactions are transferred straight to the liquidity providers, be they Tier 1 or secondary.  

On the other hand, the brokers who operate on a dealing desk basis take the role of the liquidity provider and let clients buy and sell on their trading platform. A distinct feature of a dealing desk broker is that they take the opposite side of the transaction and offload any risk with professional counterparties as and when required. Such firms effectively work as market makers and take advantage of the fact that a majority of traders lose money when they trade. 

Online forex brokers connect to various liquidity providers to get the best spreads and dealing rates. By doing so, they can provide their customers with the best price possible from multiple liquidity providers.

What To Consider When Selecting A Liquidity Provider?

In order to find the best liquidity provider, brokers are required to evaluate their own specific needs and address various factors. Firstly, they should consider the overall package of the type of liquidity offered by the liquidity provider in question. It is vital to choose a liquidity provider who can offer multi-asset liquidity and access to historical data. Market depth is another consideration when selecting a liquidity broker. It involves an indication regarding the depth of a specific country. The more the buy and sell orders at every price, the higher the market depth.

Furthermore, choose a liquidity provider who can offer quick trade executions, especially during market news with high impact. Their spreads should be competitive and commissions low with no compromise on both. Like brokers, the liquidity providers should also be regulated to ensure they operate according to the standards set. Additionally, they should be backed by a prime broker. These are some of the things you can look into when selecting a liquidity broker.

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