Forex brokerage companies connect traders with the Forex market, providing full-fledged solutions to make profits. They need to partner with liquidity providers (LPs) to execute orders immediately. LPs are specific Forex market players that hold fiat money and other assets and operate with them. Further, connecting to a trustworthy Forex liquidity provider is one of the essential criteria for a newcomer broker.
Major banks, investment institutions, hedge funds, and prime brokers are FX market makers. Liquidity aggregators connect brokerages and traders for performing transactions, thereby increasing the liquidity of dozens of trading pairs. Price gaps and slippages characterize the illiquid market, and it means that the level of Bid or Ask volume can unexpectedly change.
A highly liquid FX market seems more attractive to investors as higher liquidity reduces the cost of trading activities. Let’s review the working principles of Forex brokerages.
Forex brokers play a vital role, allowing consumers to trade popular and less in-demand currency pairs. In other words, these companies act as middlemen. FX brokerage depends on the volume of the order book, which is based on the amount of Bid/Ask transactions at a specific time. This is why LPs help brokers make trading fiat currencies straightforward for traders, allowing them to purchase or sell assets without bringing an abrupt variation in their price.
The working principle of trading operations looks like this:
1. Traders place Bid/Ask orders on brokerage platforms.
2. A Forex company passes them to global banks and other institutions.
3. Liquidity providers execute received orders.
4. A broker charges a fee that is set out in a spread.
5. Traders get their Bid/Ask order executed immediately.
This approach is highly transparent and provides investors with a quality service.
But in some cases, brokers act as the contractor in the trade. Forex companies match the trading order with the other client’s order, and this said, the broker fulfills the order as a market maker.
First, Forex is the largest financial market in the world with an average daily trading turnover of $4 trillion. Traders in all countries buy and sell fiat currencies, CFDs, commodities, energy, indices, etc. Therefore, brokerage platforms allow millions of people to do it with a small fee.
Moreover, FX companies represent a highly liquid market. Most of them are connected to the top foreign exchange liquidity supplier, known as Tier-1 provider. Global banks and large financial institutions purchase and sell different fiat currencies and provide their clients with a wide range of functions.
Many FX businesses make profits through commission or spread. Moreover, they take huge risks providing transactions on their own or delivering them to other LPs. However, some brokerages do not apply to liquidity aggregators, acting as MMs, but their order book is limited.
Most FX prime brokers operate as liquidity aggregators regarding the most popular currency pairs. They get positions from the customers and sell them to other customers during the trading session.
In general, MMs buy and sell quotes of some currencies and set a fee between Bid and Ask rate called the spread.
Furthermore, the liquidity of the FX market depends on the number of market makers operating there. The more MMs work with different fiat currencies, the fewer trading costs investors will get. It also impacts the success of Forex brokers.
Any Forex company must be stable, well-trusted, and provide a wide variety of multi-asset tools. Another vital feature is instant and reliable order filling, and this is why brokers must partner with liquidity providers, providing an advanced service.
Moreover, it is worth noting that the Forex brokerage business must connect the order book to as many LPs as possible. In addition to liquidity aggregators, brokers can involve straight-through-processing (STP) and Electronic Communication Network (ECN) brokerages to improve liquidity and rates. Only in this case, FX companies will provide investors with the best quotes and instant order execution (from 12 milliseconds). As a result, the brokerage business will attract crowds of traders and generate income.