Broker to Trading

Liquidity is an important part of trading, which affects the trading experience in different ways. Traders tend to focus on headline features such as minimum deposit and trading platforms offered. Some features, which are focused on, such as spreads, are directly related to liquidity. For example, the headline Forex spread will typically be for the most liquid pairs. This article will look at the wide range of impact that liquidity has on the trading experience and hone in on brokers and platforms that offer features for gauging liquidity and its effects.

The trading platform is the interface through which the trader interacts with the market. The market itself is a sea of liquidity, ebbing and flowing. Liquidity affects pricing and indirectly helps create patterns on the chart, which traders will focus on when trading through the platform. Some types of trading are in effect focused on liquidity, for example, news trading and short-term trading. Here, the ebb and flow of liquidity through the market affects markets, creating patterns such as trends and ranges. But what is the source of liquidity, and what are the dynamics of liquidity?

What is liquidity?

Liquidity is a measure of buying potential. Liquidity flows by moving funds from one place to another. The recipient increases their liquidity, thereby increasing their capacity to buy. Markets have a more complex dynamic, but the principle is similar. Traders transfer funds from their bank account, for example, into their trading account and then buy and sell markets with it. Liquidity providers do something similar, without the focus on directional speculation, but with a focus on maintaining an orderly market. Similarly, in the Forex market, major participants provide liquidity by buying and selling Forex (for example, for currency exchange purposes) in the huge interbank market.

It can be seen that the ebbing and flowing of liquidity can affect prices via demand, and prices are what traders focus on, or more particularly, the patterns traced out on a chart, as they attempt to speculate on the future direction of movement. Traders use tools such as technical indicators, which, in effect, tend to be based on patterns around liquidity changes. More directly, some traders will look to the depth of market information (DOM) to try to gauge potential directional pressure on a market.

But the shifting interplay of motivations and dynamics governing the disparate motivations and actions of market participants means that the effect of liquidity changes is complex and hard to predict. A core example is news trading, which aims to tie down liquidity changes consequent to market reactions to news data. Even here, the expected can become the completely unexpected. More particularly, because traders cannot influence prices directly, markets themselves may be seen as liquid or illiquid.

The liquidity of a market enhances or reduces the capacity of a trader to buy or sell a market. Illiquid markets may simply not have the liquidity (the range and depth of buy and sell orders) to accommodate an order at the price or size the trader wants. It is what the agglomeration of market participants is doing which creates liquidity, which the trader then adds to or subtracts their own funds from via payment providers, based on speculation about what these dynamics may do to price direction. The complex tapestry of market structure and dynamics, infused with the flow of money from buying and selling, is what makes for liquidity.

The source and dynamics of liquidity

Liquidity itself is simply a measure of the buying and selling of markets. At their core, markets consist of participant A selling a market and participant B buying it. The greater the demand for the market, the more its tendency to rise, and the less demand, the more its tendency to fall (up to a point). Markets that have sharp changes in demand may be seen as jagged and illiquid. These sharp changes in demand can arise from a lack of depth in the order book.

So liquidity is something more; it is a measure of the smoothness of the operation of the market (which is why some participants provide liquidity precisely to maintain this orderly operation). That is, there is a flow of buying and selling in a relatively orderly way. This can be seen as relatively smooth charting patterns versus jagged, volatile moves.

So to some extent markets are managed, but it is management of something which is let roam free by its nature (antagonistic orders with complex directional interplay). There are rules and regulations governing how they operate. Some markets are centralised; others are not. But even decentralised markets (such as forex) have rules governing them. The dynamics of Forex and other markets are influenced by liquidity providers. So let's look at what these are and what they do.

The role of liquidity providers

Traders are there to try and speculate on and exploit directional moves. As all traders know, the market does not tend to sustain directionality, or at least if it does, it evidences retracements and other complexities. Liquidity providers are major participants in markets who do not seek to exploit directionality. Rather, they are there, unsurprisingly, to provide liquidity and help maintain a well-functioning market. This means that they buy and sell, helping to create tighter bid/ask spreads to attract volume from speculative traders. Liquidity providers do not profit from the bid/ask spread. But traders on this page will be trading CFDs, so how are these affected by liquidity.

CFDs and liquidity

CFDs, or Contracts for Difference, are contracts between the client (the trader) and the provider to exchange the difference between the price of a CFD from the beginning to the end of the trade. They do not involve owning an underlying asset. However, the price of the CFD is designed to be tied to the price of the underlying market. There is a wide range of market mechanisms, including arbitrage, which helps keep the CFD and the underlying asset prices aligned.

The CFD market itself can affect the value of the underlying market as demand for a particular CFD flows and ebbs. To some extent, the CFD market and the underlying asset market can be seen as parallel markets with feedback loops between them, helping to keep them aligned but potentially affecting either. There is another key participant in liquidity, and that is the market maker.

Market makers and liquidity

A market maker provides liquidity by quoting both buy and sell prices. Liquidity providers may also set prices, but in a manner that is reactive to the ebbs and flows of the market rather than proactive in the manner of the market maker. Market makers do receive compensation from the bid/ask spread.

A CFD provider ('broker') may itself act as both a market maker and a liquidity provider. The core feature of a market is that it is dynamic and competitive, but some participants are there to facilitate its operation, while others are there to speculate. But the roles of market maker and liquidity provider, though distinctive from each other, are part of the process of creating a well-functioning market.

All this is unseen to a significant extent by the speculative trader. However, their trading platform will echo what is going on out there and also may provide more direct clues about the flow of liquidity. The flow of liquidity around the structures and functions of the market is what helps create the movement and patterns on the trader's chart.

Trading platform and liquidity

The trading platform reflects the dynamics of the market, and it reflects these in familiar ways for the trader, namely spreads and prices. Some platforms show depth of market (a range of bid and ask prices for a market), which is a key indicator of liquidity. Liquidity providers may be participants in helping create a wider range of prices and, hence, a more liquid market.

Traders themselves add liquidity depth by placing limit orders away from the current market value, so as the value of a market changes, there may be a relatively smooth order flow, helping it change without jagged jumps in value or widening of spreads. However, this can still happen around volatile market moves; spreads, for example, can widen, and volatile patterns can appear, even in the most liquid markets. Traders may try to hone in on these kinds of moves in news trading or try to avoid them, for example, staying away from the market later on Friday when positions are being closed by major participants.

However, there are different types of brokers, and the trader may wish to focus on one type or another depending on whether access to external market liquidity or broker market-making is more important to them.

Brokers and liquidity

Some brokers are market makers. What this means is that they will set prices proactively. This may result in competitive spreads since brokers are on the front line of attracting traders, and indeed, some of the tightest spreads can be seen at market makers. brokers.

However, some traders may want a broker that connects more directly to liquidity providers, sometimes labelled as ECN brokers. This is because such brokers may be able to offer very low spreads (due to access to a large competitive pool of liquidity) and may be able to offer rapid order transmission due to bypassing a dealing desk (sometimes called 'no dealing desk intervention brokers') via technology contingent on co-locating their servers in data centres with liquidity providers. Such brokers typically receive and take a commission charge, which is added to the bid/ask spread.

Liquidity as an indicator

To some significant extent, the trader is viewing the market 'through a glass darkly', and this viewing is taking place on their platform. So the platform and its charting are the reflection of liquidity. Directly, the trader can use depth-of-market (DOM) information to gauge changing liquidity.

However, liquidity is reflected on the chart itself, and this may be as or more useful than DOM for many traders. The ebbing and flowing of liquidity can be seen as the market tracing out patterns on a chart. Upward trends can be seen as an indicator of incoming liquidity as it forms and expands, and of liquidity outflow as it destabilises.

This can be quite starkly noted in the run-up to a forex session (liquidity inflows) and at the end (liquidity outflows). What happens after a trend ends can be indicative of the interaction of liquidity flows and the market. For example, does the market collapse in value, seen as a reversal, or does it merge into a more considered, ranging type of movement as traders take stock and consider what to do next.

Decoding liquidity: a comparative study of CFD trading platforms

The platforms considered on this page are MT4 vs MT5 vs cTrader vs JForex vs TradingView. These are all distinct and different platforms; they do share similarities in terms of being used by traders who trade on liquidity (e.g., news traders and automated traders) or find liquidity to be a focus for their trading. MT4, created by MetaQuotes, is the longest established of these platforms, but it has been superseded by MT5.

MT5 offers enhancements in its architecture which relate to liquidity. For example, it has an inbuilt economic calendar. From one perspective, this can be seen as a tool that is kind of like a newspaper for liquidity. It tells traders when liquidity events are going to happen (that is, data releases which can initiate money flow in and out) and gives speculative, directional predictions about the outcome of these events. This can be a roadmap for those who trade on liquidity or a signpost for those who view liquidity in different ways and wish to avoid these events. MT5 also has more time frames, which is to say a finer-grained way of viewing the chart and its patterns contingent on the ebbing and flowing of liquidity. These are reasons for considering MT5 versus MT4, though many may still prefer to use MT4.

cTrader and JForex are both current releases (each has a version that gets updated with new features). JForex is provided by Dukascopy Bank, though it is available via a white-label release at other brokers. cTrader is made by Spotware and is available, like MetaTrader, through different brokers. It might be said that cTrader is gaining popularity, judging by the growing number of brokers that offer this platform. TradingView is another third-party platform with tools for those who are interested in or trade on liquidity, including order book data.

In terms of market class availability, which potentially offers traders a wider reach in terms of the focus of liquidity flows (i.e., specific markets to trade), MT5, which is built as a multi-asset platform, might be seen as having an advantage, as brokers may offer many thousands of markets to trade on this platform (however, specific numbers depend on the particular broker). It depends on the broker and implementation, but TradingView can provide thousands of markets as well. cTrader and JForex may be seen as focused more on markets traded by automated systems and algos, though this is also the case for MT4 and MT5.

As we argue on this page, liquidity can be gauged with differing levels of clarity through charting patterns, and JForex has a particularly large number of in-built technical indicators, but all these platforms allow the trader to download and build their own technical indicators. Each uses a different language: C# for cTrader, MQL4 for MT4, MQL5 for MT5, Pine Script for TradingView, and Java for JForex. If the trader is starting from scratch and wishes to build indicators (or robots), they might consider the language as a factor in choosing a platform. The capacity to build indicators and robots is a way, albeit an advanced way, to fine-tune and customise trading approaches based on liquidity.

All of these platforms can be used for traders who are interested in or specifically trade on liquidity; however, MT5 might be preferred over MT4 due to its additional enhancements. For those who want a user-friendly interface, TradingView or cTrader might be considered. Traders who want an optimised platform dedicated to liquidity-based styles such as automated trading and scalping may choose to try JForex or MT5.

Market depth

Market depth is perhaps the most direct way that a trading platform can convey a representation of liquidity. Market depth is the order book represented as spreads of limit orders around the current marketplace. In terms of MT4, MT5, cTrader, and JForex, JForex aims to provide a particularly wide spread of prices, given its focus on scalpers and algos. MT5 improves on MT4 in this respect, and cTrader and TradingView also offer potentially valuable depth of market (DOM) information in their respective user-friendly interfaces.

Traders may use DOM as an indicator, perhaps looking for signs of changes in liquidity, but DOM is a very volatile indicator and should be considered in a holistic way with other indicators and analytics approaches. One source of DOM volatility is that traders have a wide range of reasons for placing limit orders, which may not align with the current direction of liquidity flows.

Market depth in use

The liquidity of different brokers can vary, and some brokers may focus on providing liquidity to match the quoted price even for larger orders, which is to say, reducing slippage, where all or part of the order is filled at a different price. Many traders trade on market orders; it is also possible to trade on limit orders.

Limit orders are orders to be filled when the price of the market being traded reaches this value. If traders have ever traded in a market that is limit-order only (which may be a consequence of illiquidity due to volatility, for example), they may be familiar with this concept. Limit orders can be useful for traders speculating on direction and filling an order when it seems like their trade may be valid.

However, to trade a limit order there and then or at a future date, the trader can check the depth of market, which is to say, the order book depth, and see if there are sufficient orders matching their desired fill at that price. The trader may notice that the order book changes, and indeed the rate at which the order book changes is related to the liquidity of a market (which itself is dynamic).

So at the time the trade is made, there may not be sufficient liquidity. However, if a trade does become valid, it may be the case that those trading on market orders will crowd into the trade, which can have an effect on liquidity. So the data of the order book is valid for that time and may not be valid later. However, like all market data, it can be seen as an indicator of potential market activity. A DOM heat map is a way of seeing the order book and how it dynamically alters, and it may be useful as an indicator of potential changes in a trend, for example, though the effectiveness of this may be contingent on how well the heat map represents liquidity flows.

Brief summary

Looking at key components of liquidity in CFD trading: firstly, the trader adds liquidity to their account by depositing. This gives them buying power. What they can buy and at what price depends on their account liquidity and other factors such as risk management and leverage. When an order is placed, the CFD provider will create a contract to exchange the difference between the value of the CFD at the beginning and end of the trade and then likely hedge their exposure.

In the case of CFD trading, the external market is not where the order is matched but rather plays a role in determining the price (as the contract price is aligned with the real asset price) and how much of the order the provider can fill at the quoted price. This is a function of risk management as well as the capacity to access resources, such as liquidity providers, to enable the provider to effectively offer CFDs to the trader at the desired price.

Trade on a demo account

Liquidity is a complex factor in trading, and these platforms are used in ways that can be considered advanced. Thus, the trader can try out the platform of their choice on a demo account and get to grips with the various factors and issues in trading or using liquidity as an indicator in trading before using a live account.