Detailed Explanation of Forex Trading Volume and Liquidity Providers (LPs)

Liquidity Providers (LP) are an indispensable part of the foreign exchange market. Liquidity is key to an efficient market structure, ensuring there are immediate buyers and sellers for trading orders, which in turn facilitates easier transaction processes, lower trading costs, and more competitive pricing for currency pairs. Hence, the presence of liquidity is what makes the forex market thrive. Without it, many traders would find forex trading to be impractical.

Liquidity is measured by three main factors: size, price, and time. When liquidity is abundant, investors can successfully make large transactions near real-time prices quickly. Additionally, a popular indicator of liquidity is the bid-ask spread, often referred to as the "spread." Liquidity is a crucial characteristic of a well-functioning market because it instills confidence in participants towards the forex market. The global forex market now has a daily trading volume of up to 6.6 trillion US dollars, making it the most liquid market in the global financial landscape! Market liquidity providers engage in buying and selling foreign exchange with smaller banks, brokers, and companies. Then, smaller brokers can parcel out these positions and offer them to retail participants in the market. In reality, liquidity providers and their clients are in a mutually dependent cooperation model, as both need each other to maintain operations.

Forex liquidity providers act as the intermediaries that clear orders into the international markets, offering liquidity data services for the interbank foreign exchange market and fetching the best prices for downstream retail forex brokers. The technological development in liquidity is a focus for liquidity providers, offering technical support for the STP/ECN models of medium and small forex brokers. Moreover, liquidity providers usually connect with more than two major banks, designating one as a backup to ensure continuous and stable liquidity.

The forex market is the most liquid market globally, with participants including large banks, central banks, institutional investors, retail forex traders, corporations, governments, other financial institutions, and individual investors. Their high volume of transactions enhances market liquidity. Banks, governments, and corporations are the primary participants in forex trading. With the development of internet platforms, the proportion of individual investors has gradually increased. Generally, the more orders and larger the trading volume, the better the liquidity. In extreme cases, however, the market may face a flash crash, for instance, when everyone wants to sell their positions at the same time, leading to liquidity drying up and prices continuously falling. What constitutes a "black swan" event in the forex market? In the practical world of forex trading, client orders might involve slippage, but ample liquidity and huge trading volumes can prevent excessive slippage. At this moment, a highly transparent platform becomes crucial.

Liquidity providers are actually divided into different levels. To access the top-tier liquidity, one must choose providers closest to the interbank foreign exchange market, such as major international banks including Citibank, Deutsche Bank, HSBC, JPMorgan, UBS, and ING (as well as some insurance and fund companies like Quantum Funds and BlackRock that also have quoting rights in the forex market). All orders eventually end up at these banks, which handle them in two ways. First is hedging, and if hedging is incomplete, they will offload to each other. When a bank accepts too many orders and holds too many net positions, it poses a significant risk. So, if a bank has hedged but still holds 10,000 EUR/USD short positions, it will offer a price to its interbank partners. A bank with enough long positions will take these orders, leveling the positions.

However, it’s not always possible to have an equal number of short and long positions, and there are parts of these banks' risk positions that they cannot offload to each other, intended for speculative profit, which aren’t too excessive. Hence, banks also rely on their risk management systems to decide which orders to take or reject, and they won’t foolishly accept counter-orders in a one-sided market trend, which would deteriorate market liquidity.

Although obtaining top-tier liquidity means choosing internationally renowned big banks, brokers face a practical problem. Connecting with these large international banks requires not only a significant capital but also high technical barriers. Therefore, most brokers opt not to directly connect with top-tier international banks but instead work with non-bank liquidity providers.