Trust, Flexibility and Net Open Position Limit: How to Choose a Liquidity Provider

As forex brokers strive to provide the best trading experience for their clients, the choice of liquidity provider (LP) is a critical decision. In a recent article by Finance Magnates, the author highlights the key factors brokers consider when selecting an LP. These include liquidity quality and reliability, technology and pricing, and the ability to offer customized solutions. In this next part, I'd like to delve deeper into more technical aspects of cooperation between a forex broker and its liquidity provider to show why they are so crucial to the success of a forex brokerage.

The Net Open Position Limit

Another essential aspect to consider when choosing an LP is the Net Open Position (NOP) Limit. Each LP has its internally established limits, which depend on the acceptable risk level of the provider and its liquidity suppliers. The NOP limit can be influenced by various factors, such as:

• Instrument liquidity – more significant limits for more liquid and popular instruments and smaller limits for exotic ones.
• Instrument volatility – instruments whose price can change by a few % during the day, such as indices or oil, will have different limits than, for example, EURUSD.
• Instrument correlations – some instruments can be combined into one NOP Limit due to their correlation, such as WTI and Brent oil or American indices.
• Distribution of exposure – depending on whether net exposure is generated by one high-net-worth individual or hundreds of traders, LP may apply different approaches.

In addition, NOP Limits can change over time. Many liquidity providers have different NOP Limits during the workweek and different ones for positions left over the weekend. However, in the case of significant expected volatility, such as during the US elections or an important FED meeting, liquidity providers may temporarily lower NOP limits.

Why must the broker verify all these aspects before signing a contract with an LP? Because without this information, they will not know what risks they can hedge with that specific liquidity provider. Failure to understand these limits may result in rejected orders or brokers being asked to close part of their exposure.

It's All About Trust

B2B cooperation is mainly based on relationships, which is the same as the broker and the liquidity provider. A crucial aspect when choosing an LP is understanding who we will be doing business with and the decision-making process. In most cases, conversations start with salespeople responsible for acquiring new brokers, who then fall under the care of support teams.

Although we may have established a partner relationship with the salesperson during the entire sales process, they will not have much influence on our service. Therefore, it is essential to get to know the people we will be working with, understand the decision-making process at the LP, and know who will make the final decision in disputed situations.

In relationships between LPs and brokers, certain orders are often rejected, no quotes from LPs for some time, or a broker's employee misconfigured multipliers in the bridge, causing the broker to hedge incorrect positions. Of course, all these situations can be resolved, but it requires significant flexibility from one party, usually the LP as a service provider.

Flexibility and Symbol Settings Adjustment

In the previous article, we mentioned the "Range of financial instruments," which is essential, but in practice, we must consider what settings LPs have applied to specific symbols. Thus, it is necessary to take into account:

• Underlying instrument – CFDs can be based on slightly different instruments than we are used to.
• Contract sizes – LPs may quote some instruments with contract sizes that will prevent us from accurately replicating the position.
• Multiplier currency – some instruments on the LP side may have a different multiplier currency, e.g., using USD for Nikkei225 instead of JPY.
• Trading hours – are they the same as with other LPs?
• Decimal places of symbols – some instruments may have an extra decimal place that is not available on the original underlying mechanism.

Comparing symbol settings is as important as their availability, as significant differences in stages can make it impossible for the broker to use some instruments.

End-of-Day Reports

A very convenient solution for the broker is adjusting the time of generating EOD reports to their needs. The broker and the LP may operate in two completely different time zones, meaning their end-of-day may be several hours apart. For the broker, this means the inability to easily compare exposures, which causes problems in calculating the Capital Adequacy Ratio (CAR). Additionally, reconciling daily profits when two reports are several hours apart is like comparing apples and oranges, especially with a hedge account operating in the FIFO model.

Selecting the right Liquidity Provider (LP) is crucial for forex brokers who want to provide their clients with the best trading experience. In addition to essential factors like liquidity and reliability, brokers must consider several technical aspects of cooperation with their chosen LP.

These include understanding the Net Open Position (NOP) Limits, getting to know the people involved in the decision-making process, or the flexibility of adjusting symbol settings to examine the full potential of such cooperation. By considering these technical aspects, brokers can ensure they are partnering with an LP that is well-suited to their needs and can provide them with the support they need to succeed in the forex market.