Whether you are looking for a revenue share or an STP deal with your LP there are key factors besides the basic commercials that you should pay attention to in order to make sure that you attain the best setup possible.
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In this article we will discuss some of these key factors and show you how to analyze them.
Deal Terms (STP)
With an STP scenario the two obvious factors are spread and commission. The lower the spread and commission of your LP the higher the markup you will be able to capture and the more competitive you will be on price.
STP Deal Execution Quality
In addition to price, you also need to pay attention to execution quality. Your LP can be showing a very tight price but slipping you or rejecting you on every trade. You need to test this. There are tools that track execution quality, where you can measure the average slippage on a trade, and the fill/rejection ratios.
If you are going to be using just one LP it would behoove you to set up a test account and send in a bunch of manual and algo trades and measure the execution quality of your LP. If you are aggregating LP’s you can add the LP to your mix on your connectivity provider and compare it to the other LP’s. If the rejection rates are high you can simply remove it.
Also you can ask your prospective LP to provide the average fill ratio of their other broker clients in order to gage their execution quality. Liquidity will be a main topic of discussion at the 2017 London Summit next week.
Another thing you should pay attention to is your LP’s look back period. Some LP’s offer Firm liquidity. This means that every price that is offered in your stream is firm and cannot be rejected by LP’s via last look.
This is good for you since your clients will have very low reject rates. Other LP’s give themselves a look back period of x milliseconds to decide whether to reject trades or not. You want this window to be as little as possible.
Deal Terms (Revenue Share Deals)
With a revenue share deal the LP, basically acts as a market maker and takes the other side of your client’s trades. If your clients lose the LP will make money and share a portion of that money with you, hence Revenue-Share.
The key factor to pay attention to with a revenue share deal is downside risk. With revenue share deals there are symmetrical and asymmetrical deals. With a symmetrical deals if your clients make money the LP and you essentially both are losing money and you will need to send your money to the LP each month or quarter.
With an asymmetrical deal when your clients make money you will also be losing money along with your LP but you don’t actually have to send in the loss rather it will carry over towards your next month’s gain as in a high watermark structure.
Obviously from a risk standpoint having an asymmetrical deal is much better for you as you don’t have to send in additional funds into your coverage account.
The other factor to pay attention to with a revenue share deal is the percentage you get. Depending on the LP and deal parameters payouts vary from 20% all the way up to 60% of market making revenue.
Client profiling is key here, you don’t want to send winning traders into a deal structure where you benefit from them losing. Ideally you want to get a combo deal where you can STP winning traders and send the losing traders to a revenue share deal.
The location of your LP’s server is another fairly simple parameter that you need to pay attention to. If your server is located in London you should only use LP’s whose servers are in London otherwise it will take to long for the LP’s prices to hit your servers and your client’s trades to hit your LP’s server.
This either creates arbitrage opportunities for your clients or causes you to provide clients with poor execution. Therefore make sure that the LP you choose has its server in the same location as you.
Do your client’s want to trade a specific product/instrument? OTC forex brokers typically offer clients at least 40 currency pairs, metals, and CFD’s. Some traders like single stock CFD’s.
Additionally some traders may want NDF’s and of course Cryptocurrencies. So the key here is to keep in mind the Pareto principle (also known as the famous 80-20 rule). Do you have any big clients that require a specific instrument or product? Do they require special pricing on this product? If these are the clients that make you the money, you better make sure that your LP can accommodate them.
Safety of Funds
In most cases you will be placing margin with your LP. When placing margin you want to make as sure as possible that your LP doesn’t go out of business and take your money with them. Therefore it is highly recommended to do as much due diligence as possible on the size and stability of your LP prior to sending in your money.
There are three shortcuts to doing this due diligence: Where is the LP regulated? – Let the regulators do the bulk of the analysis work for you. A broker that is regulated with the FCA or ASIC has to meet pretty stringent requirements and keep a pretty sizable amount of capital on hand.
Does your broker LP have a PB – Although having a PB will make your LP a bit more expensive it should provide you with a piece of mind about it’s stability. Especially after the SNB crisis prime brokers are more selective of their forex broker clients. So if your LP has a PB it’s a good sign about their stability and financial health.
Check your LP’s balance sheet – typically LP’s will provide you with their balance sheet after you sign an NDA. A strong balance sheet 10 million + on hand is a good sign.
A connectivity provide is how your broker connects to its liquidity. You probably heard the names like OneZero and PrimeXM. Those are the two premier connectivity providers.
These tools connect you to your LP’s allow you to aggregate them and provide you a bridge to your MT4 platform. There is of course a per million ticket fee for using these tools.
One way to save money on these fees is to use an LP that has the same connectivity provider as you. With OneZero this is called The Ecosystem and with PrimeXM it’s called the XCore to XCore connection. Essentially the connectivity providers will give you a discount if you connect to and LP that has the same connectivity provider.
What leverage do you want to offer your clients? If your clients require a high leverage like 500:1 and you are only getting 50:1 from your LP it can cause problems and either require you to have a huge amount of margin up with your LP or leave you exposed.
The downside is that the bigger more stable LP’s rarely offer high leverage. Being able to get 200:1 is great and 100:1 is good. So this is something that you should look for.
These are some of the key factors to pay attention to. Others will come up and the big key is to pay attention to your client base. Where are they coming from? And what/how are they trading? And make sure that your LP relationship is conducive to it.
If you have a bunch of beginner clients trading manually and technically that you want a revenue share deal. If you have a bunch of Algo traders STP. That is your starting point and the other parameters should be adjusted from there. If you want to find an LP to match your needs check out our liquidity wizard at lqedge.com
Alex Nekritin is the Managing Director of Nekstream Global, a liquidity and technology consulting company helping brokers, HFT traders and money managers to find proper liquidity and tools for their ventures. Alex has over 10 years of experience in the financial space. Contact Nekstream at email@example.com. Also check out Nekstream’s latest project lqedge.com where you can enter your liquidity requirements to quickly find matching LP’s.