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How Do Liquidity Providers Make Money and Are They Market Makers?

I’ve already talked about the difference of the true and false or fake ECN/STP brokers. Make sure not to miss these posts, because they are very important for someone like you who wants to make a living through trading: The Difference of True and False ECN/STP Brokers

As you have learned from this article, an ECN/STP broker is the one that routes the traders’ orders to one liquidity provider at least, without any human intervention. If that liquidity provider is a well-known and trusted organization like Nomura or Deutsche Bank, then the broker is a true ECN/STP broker that doesn’t manipulate your trades and doesn’t trade against you.

Now, the question is whether the liquidity providers go against you, or they are happy with the spread and swap they make out of your positions? Is the spread and swap the only income source of liquidity providers or they have some other ways to make money? Do good liquidity providers bother to make you lose, the way market maker brokers do?

Liquidity providing and the spread and swap the liquidity providers earn through this service is only one of the income sources that famous liquidity providers have. They offer too many other services and have too many investment activities.

Like a market maker broker, they lose money when you win. However, as they are too big and offer their services to numerous companies and clients, the small losses are always recovered by the profits they make.

More than 95% of the traders lose and so their money stays in the liquidity provider’s pocket. But the difference of a big liquidity provider like Deutsche Bank with a market maker broker is that they are too big and they make much more profit through the services they offer. Therefore, they don’t bother to make retail traders lose.

Even if you make them lose, they still appreciate your business, because the money you transfer to them and stays with them when you take and hold your position will be added to their treasury and they use it for too many other purposes.

At the same time that you buy a currency, they sell another currency to someone else. They buy and sell stocks and shares. They lend money to big investors, other banks and organizations, and even governments, and they earn a lot of profit.

Your money helps them handle all these activities, and they help you trade. They handle millions of transactions 24 hours per day and 7 days per week, even when the currency market is closed to retail traders on weekends.

So, it doesn’t make sense for them to go against the traders and make them lose. They usually don’t do it, because they don’t have to. Besides, they are always worried about competition and so they have to offer a better service every second. Just a small mistake can ruin their credit and cause them to lose a lot of business. On the other hand, they are closely supervised by the governments and if they make any mistakes, they will have to pay for it badly.

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Liquidity Providers and True ECN/STP Brokers Relationship

Unlike market maker brokers, true ECN/STP brokers route the traders’ orders to interbanks that are also known as liquidity providers: The Difference of True and False ECN/STP Brokers

So, true ECN/STP brokers are just mediators. They charge a small fee for each transaction. This fee is called commission which is the only legal and legitimate way for these brokers to make money. They don’t make any money from the traders losses, nor they lose any money if traders win.

Liquidity

Liquidity

Nowadays, almost all the true ECN/STP brokers are connected to several strong and famous liquidity providers, whereas in the past they were used to work with only one or a few. These are some of the most famous liquidity providers: Bank of America, Goldman Sachs, JP Morgan, Citi Bank, Nomura, HSBC, Deutsche Bank, Royal Bank, TD Bank, Barclays, Wells Fargo

When a trader clicks on the buy or sell button, the broker chooses one of the liquidity providers that is offering the best price which is the closest to the price that the trader sees on the broker’s platform. Then the broker transfers the order to that liquidity provider. Each of the liquidity providers can offer a price which is usually different from what the traders see on the platform, because the platform’s price can be from only one price resource, not from all the liquidity providers. Therefore, when the order is placed, your entry price will be different from what it was when you clicked on the buy/sell button. This difference can be from a few pips to several pips depend on the market condition. But it is too close to the platform’s price 99% of the time.

The order will be placed when the liquidity provider accepts it. They usually accept the orders most of the time, unless the order is too big and the market is not liquid enough or is too liquid and volatile.

Let’s say your order is placed. The question is whether the liquidity provider knows you as the trader or not. Does it know that which order is placed by which trader?

The answer is, liquidity providers only know the brokers. From their point of view, it is the broker that is placing the orders, not you. They don’t know the retail traders. A broker can have thousands of open positions with each liquidity provider at the same time.

What the difference does this make to you?

The more you know about the brokers and liquidity providers, the easier you can choose a good broker who is honest and doesn’t lie to its clients.

Some brokers say that they don’t allow the liquidity providers to see the stop loss, target and pending orders, because they don’t want them to know the profitable traders and prevent them from making profit. As I mentioned, liquidity providers don’t know the traders. They only know the broker and the positions it takes. As over 95% of the traders always lose, then 95% of the orders that a broker routes to each liquidity provider are losing orders. So there is no point to prevent the winning positions, because the liquidity providers make enough money through the losing positions, and many other things: How Do the Liquidity Providers Make Money?

Also, as brokers scatter the orders among several liquidity providers, then each liquidity provider will have an equal share from the losing and winning orders that each broker sends, and they will not be under the attack of too many winning positions at the same time. This is really good for traders.

Each broker has an account with each liquidity provider, exactly like the account a trader has with the broker. Liquidity providers offer a 100:1 leverage to brokers (of course the famous and strong liquidity providers I listed above, not a small and unknown bank at the middle of Pacific Ocean, or a marker maker retail broker that also offers a liquidity providing service to the other brokers).

Brokers have to deposit enough money to the accounts they have with the liquidity providers. They have to top up their accounts when their clients (traders) lose money, otherwise they can reach the margin call and stop out level. If so, their clients will not be able to place any new orders, and the liquidity provider starts closing the losing positions. This is what a broker never wants to happen, because it will have a very bad impression on the traders minds. They will ask why the negative positions are closed while they still had enough money in their accounts. This is a right question, because the traders had money in their accounts, but it was the broker that didn’t have enough money in the account it has with the liquidity provider. Traders don’t know what is going on behind the scene. They only see the positions that are closed without any reason.

So, the money that a true ECN/STP broker takes from its clients, has to be deposited in the account the broker has with the liquidity providers. Usually they place 50% of the money they take from the clients. As their income, they deduct the commission they make from the orders.

A true ECN/STP broker has to be careful not to overspend the money it takes from the clients, because a too strong market movement can suddenly take the broker account balance down, and so, the broker will have to top up the account immediately before it reaches the stop out and margin call levels. They need money to do that. If they spent the money for the other purposes like office expenses, salaries, advertisement and…, they will get into serious problems.

Sometimes, a too strong market movement causes some positions to have negative balances. It is the broker who has to pay this balance to the liquidity providers, not the traders. But it is the traders who have to pay their negative balance to the broker. However, traders usually walk away and will never pay for the negative balance. The broker will have to prosecute each trader, which will be too expensive. So the broker prefers to shut down and get out of the game. They can get prosecuted by the liquidity providers too. It depends on the contract they have with each other. These are all possibilities. They usually don’t happen even once every 10 years.

Now, I am going to ask you some questions. The best answer will be rewarded with 1000 points. Here is the question:

100:1 is the maximum leverage that liquidity providers offer to the true ECN/STP brokers. What happens if a true ECN/STP broker offers a higher leverage, like 500:1, to its clients? How the orders will be handled then, and who will be the loser or winner if this leverage difference causes any losses or gains?

What happens if a true ECN/STP broker offers a lower leverage, like 50:1, to its clients?

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35 thoughts on “How Do Liquidity Providers Make Money and Are They Market Makers?
  1. Dogan says:

    I think some brokers dealing with their clients both way. They could be ECN STP broker and money maker as well. If you have micro account you never know when they change their operation to you. As a learner of trading how possible to find out good broker? Instead of using demo account I’m working with small amount of money and 0.01 size of lot. I know you will not give us reliable brokers name. But I think you may give us a list of good Brokers.
    Thanks for your help.

  2. alwin says:

    Dear Chris,

    Please help me & provide good Liquidity Providers. This information relay helpful so many New learner

  3. james says:

    hi Chris
    I have two questions
    1.can ecn brokers be still market makers
    2.the size of the lot do ecn brokers provide
    thanks for the work of educating us Chris may God bless you

    • Chris says:

      Hi James,

      1. Some brokers have both systems, ECN and dealing desk. They place some of the account on ECN, and some others on DD.

      2. 0.1 lot is the minimum lot size true ECN/STP brokers can support.

  4. Nick says:

    Hi Chris will LuckScout be closed for the holidays?

  5. Maria says:

    Hi Chris,

    If a broker is a true ECN/STP broker, will they always tell us what their liquidity providers (banks) are? Or is there any true ECN/STP broker that has a company regulation where they should not tell anybody about it?

    • Chris says:

      Hi Maria,

      They proudly tell you who their liquidity providers are in case they work with good liquidity providers. If they don’t, then there is something wrong.

  6. Ted says:

    Another subject demystified!!

    Thank you Chris

    Ted

  7. Mahesh says:

    Hi Chris,

    Today i received an email from my broker saying they will be reducing the allowed leverage on EUR/CHF due to changing market conditions. Do you think this is odd?

  8. Sutivserv says:

    In your analysis of G/A, you said the price is approaching resistance level @ 1.9183 and if you are in a long position, “you have to be careful”.
    What exactly are you suppose to do at this position in order to be a better trader?

    • Chris says:

      You can collect your profit, or move the stop loss to breakeven to be at the safe side. It depends on the risk you want to take. You can risk the profit your position has and leave the trade open maybe to make more profit. It is up to you and is a personal decision.

  9. Nick says:

    Thank you Chris and enjoy the traveling!

  10. Adam says:

    Re the GBP/AUD trade, I’m confused why this would have been a valid trade. NZD/CHF daily was dismissed as a trade last week with one of the negatives being because the confirmation candle was too long so the market was deemed overbought; didn’t the GBP/AUD trade have the same characteristics?

  11. Val says:

    Hi!

    Can you tell me, what is the minimum lot size in units that the liqudity provider can really handle/trade?

    Thank You

  12. Any D says:

    I don’t know if the biggest liquidity providers are honest: http://en.wikipedia.org/wiki/ _scandal

  13. titanium says:

    Hi, Chris. Still have some doubts about how banks/market makers work. Do they have money in many currency, or convert their currency automatically based on the currency you need. For example, you want to buy CHF, so they convert USD in CHF.

    • They usually have different currencies in their treasury. It doesn’t make sense to convert currencies when someone wants to buy a currency they don’t have, unless they charge the customer a lot to cover the possible losses.

  14. titanium says:

    Oh, thanks. It is exactly what I thought? But what if they want to convert their main currency with a currency they don’t have, or what if they have too much foreign currency and what to convert it in local currency? Do they do it with their central bank?

  15. James Milner says:

    So does that mean they don’t like scalpers as they don’t hold positions for very long?

  16. Ufoo says:

    Hello luckscout team, I have a questions regarding market makers:
    – Is it true that false breakouts are caused by market makers as a way of misleading retail traders so as to make retail traders money?
    – Do market makers cause false breakouts so as to mislead retail traders and take their money? Are all false breakouts caused by market makers?

    Thanks

    • – They can do it if they want. But it doesn’t mean that all false breakouts are done by MM brokers.

      – If they do it, they do it to hunt the stop losses.

      • Ufoo says:

        Thanks. A follow on question please. Excuse my nagging: how then can I protect myself from market makers? Is there anyway at all?

        • Unfortunately not, because nowadays almost all retail brokers, even those who claim to be pure ECN/STP, have a MM system at the same time. They place the small and also the losing accounts on the MM system while the clients think they are on the ECN/STP and trading with the real currency market.

          Retail brokers somehow have to do this to survive because their income through an ECN/STP is very low. A client can wipe out a $200,000 account with one single trade that makes only $100-1000 for the broker, if the account is on the ECN/STP system. BUT if such an account was on a MM system, then all the $200,000 would be in the broker’s pocket.

          This is the money that brokers can’t ignore and can’t let it be lost by offering ECN/STP accounts.

          The solution is that you stop trading through the retail brokers completely and change your approach to currency trading. You have to turn from a retail to an advanced currency trader:
          https://www.luckscout.com/short-term-investment-strategy/

  17. U4 says:

    Thank you. 2 more questions please:
    1) After reading some books I have learnt 2 ways that I can use to protect my money from Market makers during breakouts. Please correct me/ comment:
    – Trading fakeouts instead of breakouts
    – if one chooses to trade the breakout, putting a wide stop loss and then monitoring the charts.
    2) How much capital do I need in order to become an advanced trader? This is following your answer to my previous question. Thanks again

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