CFD Liquidity Providers take the opposite side of trades placed against CFD trading instruments by retail CFD Brokers, institutions, and individual traders with big volumes. CFD LPs provide seamless liquidity to CFD Trading venues and ensure that the traders are able to enter and exit into trades without any trouble.
This article is written particularly for CFD Brokers or the aspiring entrepreneurs who want to start their own CFD brokerage and run it on A Book.
We will discuss the brief about the CFDs, who are the CFD liquidity providers, how they work, the difference between forex liquidity providers and CFD liquidity providers.
What are CFDs?
CFD stands for “Contract for Difference” where traders (buyer and seller) enter into a contract to buy and sell an instrument for a target price. This contact has an expiry date. These buyers and sellers make money when the price moves towards their target price of hit it.
CFDs are essentially derivative instruments wherein they derive their value or price from an underlying asset.
Another key element of Contract for difference is that they are highly leveraged OTC (over the counter) trading instruments. This is means the traders can take large positions with a relatively small margin. Thereby their profits and losses are proportionally high and low too.
Who are CFD Liquidity Providers?
CFD Liquidity Providers are third parties that provide liquidity to CFD brokers and other trading venues that offer CFD instruments for trading to their clients.
CFD Liquidity Providers keep offering both bids and ask for a CFD instrument. The difference between these bids and asks which is called SPREAD is very low and in some cases almost nil.
This gives high liquidity to CFD trading venues like CFD brokers and makes them trustworthy to their clients.
Liquidity is the lifeblood of any trading platform be it forex brokers or CFD brokers.
How do CFD Liquidity Providers work?
Here is a step by step process with little technical stuff about how do CFD Liquidity Providers actually work with CFD Brokers. We will discuss it from a CFD broker’s point of view so it won’t have the internal workings of CFD Liquidity Providers.
- CFD Liquidity Providers usually provide an API or Liquidity Bridge to CFD brokers and other trading venues.
- These CFD Liquidity API and/or Bridge are compatible with different CFD trading platforms like B2Broker, Match Trader, Utip etc.
- Most of CFD Liquidity Providers have a set list of CFD instruments for which they can provide the liquidity.
- This list usually consists of spread as well for these CFD instruments.
- A CFD Broker needs to pick and share the list of CFD instruments that they want the liquidity for.
- CFD Liquidity Providers have specific volume and deposit requirement to provide the liquidity to CFD brokers and other venues. Their charges and deposit may vary depending on the volumes. Higher volumes may get you best deals.
- An agreement is signed between a CFD Liquidity Provider & CFD Broker. Deposits need to be made by the broker.
- Upon fulfilment of terms and conditions by brokers, CFD LPs tech and support team works with broker and establish the liquidity connection.
- The liquidity flow starts and CFD broker need to set whether all clients’ trades will be sent to LP or a specific group of traders’.
- CFD brokers are advised to properly test the liquidity connection and feeds for proper functioning.
- The work starts and CFD LPs support team assists with any issues the brokers may face with CFD liquidity.
Difference between CFD Liquidity Providers & Forex Liquidity providers
I. Number of Trading Instruments
CFD Liquidity Providers business is a little tricky unlike forex liquidity providers and there could be unlimited CFD trading instruments. There is a handful of Forex instruments that forex brokers offer traders for trading.
Remember, we have explained how CFDs are actually derivative instruments that derive their value from other trading instruments.
So when you trade into CFDs, you are not trading into the actual assets behind it. You are just trading for the price difference till the contract’s expiry. If price moves in your favourable direction, you make money else you lose it.
Since CFDs can have thousands of instruments; providing seamless liquidity with real-time price quotes become very expensive in terms of connectivity, bandwidth, storage and other resources.
Latency with CFD Liquidity takes a hit during the high volatility days like news, unprecedented events etc.
Forex Liquidity providers are a little luckier here with limited currency pairs to provide liquidity pairs. Even among these limited currency pairs, only a few exotic forex pairs give the highest trading volume. This makes Liquidity Providers jobs much easier in comparison to CFD Liquidity providers’
Every Liquidity Provider be it Forex Liquidity Provider, Crypto Liquidity Provider or CFD Liquidity Provider take a risk by taking the opposite side of trades. Trading being a zero-sum game where you make money when the counterparty loses it and vice versa, LPs carry significant risks.
LPs offset or manage the risk by hedging their positions against the same or other instruments which are correlated.
Hedging for Forex Liquidity Providers is relatively easier as there are limited pairs and they already know the correlation between different currency pairs.
Co-relation between different currency pairs depicts the behaviour in price movement of one currency pair with another currency pair. Some pairs move in the same direction as each other which some move in the opposite direction.
The correlation between different currency pairs is very established, this makes hedging for forex liquidity providers very easy. They simply take the position in a co-related pair against a position where their risk management team thinks they may lose.
Hedging for CFD Liquidity Providers is very complicated as there are thousands of CFD instruments that derive value from different assets and instruments which may be actually being traded on some exchanges.
If a CFD Liquidity provider wants to take a hedging position on the real instrument on an exchange they may not do so due to different regulations in different countries and exchanges.
Another difficulty is in vague co-relation between different CFD instruments. Establishing co-relation between different CFD instruments is a daunting task and cannot be done as easily as with forex pairs. This makes hedging for CFD Liquidity providers much more complicated.
If you are planning to start a CFD Brokerage Business and considering running it on A Book where you would send your clients trades for execution to a third party, CFD Liquidity Providers are your best option.
CFD Brokerage business is a little more complicated than a Forex Brokerage business as your traders may demand different CFD instruments.
And if you keep honouring all their requests, the number of CFD instruments on your platform will even cross thousands.
So you must draw a limit to which requests to honour and which ones to decline politely. One simple method is to see how many of your clients are requesting an instrument.
You can keep adding the requests and conduct a pole periodically maybe every month or quarterly. And add the instruments that get the most votes.
Apart from this, you need to check with your CFD Liquidity provider as well whether they provide liquidity for these instruments or not and even if they do, what are the charges.
Hope with this article we could educate about the CFD Liquidity Providers.
Wish you the best!