How to Build the Best Forex Liquidity Feed

Last week we published an article on why buy-side FX firms need a custom price feed. In the article, we emphasised why a one-size-fits-all approach simply doesn’t work in the wholesale liquidity space because every client is different. However, it’s not just well-capitalised firms that can benefit from a tailormade price feed. Access to the best forex liquidity feed shouldn’t be exclusive to large institutions churning hundreds of lots per day. 

Arguably, it’s fresh-faced startup money managers and multi-account managers that stand to gain the most from partnering with an FX liquidity provider (LP) that offers customised price feeds and the opportunity to optimise on-demand. As your strategy takes on more funds, naturally, your position size and exposure is going to increase, and that changes many characteristics of the strategy. 

Imagine having to recruit new LPs every time your fund reaches new milestones because you suffer from an increase in slippage, order rejections, or start to feel other flaws when you begin to hit lower tiers in the book. Growth should be a privilege, not a pain. 

The first step we take when connecting with prospective clients is to build a profile of their strategy and anticipated flow. We understand there are tough questions in the beginning, but our relationship managers help to create this profile with you. Based on the profile, our reception and transmission officers and analysts can assess how we can meet the requirements and make a proposal. The proposal isn’t merely about price but also defines various commitments and targets that can be quantified later on.

In this article, we will explore the multifaceted approach that Scandinavian Capital Markets takes when onboarding new clients and how we ensure our liquidity provision will scale alongside your strategy.

Metrics to analyse and build a high-quality of forex liquidity feed

There are numerous factors to be considered when designing the best forex liquidity feed for your trading strategy. There is no shortage of prime brokers or trading venues in the OTC FX market. The diversity of the wholesale liquidity market presents numerous LP options, each with their individual qualities. By understanding the needs of each client, we can identify which streams will provide or contribute towards achieving the necessary conditions. 

The following metrics are how we catalogue our roster of LPs.

Round-trip time & execution time

The round-trip time is how long it takes for an order to travel to an LP via the internet and for the acknowledgement to be returned. The execution time is how long it takes to be processed internally. The longer it takes to fill and order, the higher the chance of slippage occurring. Yes, slippage can be positive or negative, but that is a gamble and therefore, something to eliminate for a refined trading strategy.

One way to reduce the round-trip time is to ensure orders are being submitted from a location as close as possible to the LP. The best way to reduce journey time is to concentrate all intermediaries in one place. For example, LPs, aggregators, trading platforms and virtual private servers can all be hosted in the same location. If your entire stack is co-located in London, it may not make sense to introduce an LP in New York or Tokyo if there is a comparable alternative also based out of London.

Fill ratios (reject ratios)

It is essential to look at the proportion of how many orders are filled versus how many are rejected. This metric can be determined either as a number of orders or as a percentage of order volume. The reason for orders being rejected can vary. Sometimes it’s down to technology issues like delays, packet loss, stale quotes and bugs. Other times it can be due to an inability to fill large orders. 

Quote frequency

If an LP is sending excessive price updates, it can create numerous issues. One issue is related to performance. By streaming too many quotes, it can lead to overburdening the trading platform, the aggregator or congesting the bandwidth, mainly if multiple price feeds are being aggregated alongside the LP sending too many quotes.

By streaming too many quotes, there is a high probability that a quote is already stale when you receive it. Stale quotes can lead to a high level of rejections for limit orders and slippage on market orders.

Technical compatibility

Although the industry is almost entirely on the FIX API standard, that doesn’t mean there aren’t other technical variables to consider. There are numerous bridges, aggregators and platforms on the market. We ensure there are no technical barriers preventing clients from getting pricing from the LPs they want. We make sure there are no unnecessary steps involved in the transaction process.

Execution cost

Execution cost goes further than the spread. LPs charge volume fees. We’re confident that we get the best possible fees from our partners; however, each LP we cooperate with has a different pricing structure which must be considered. Technology also plays a role in the overall cost.

Pricing

There are a few areas to consider when it comes to pricing; the top of the book prices, level two pricing, skewing, widening, spiking and gapping. An LP might;

• have very tight quotes at the top of the book, but there may only be 500k on the top level. We need to see how far away the lower levels are. It could be one point away or ten points away;
• not have the tightest quotes at level one but may have great depth, helping to get a better overall volume-weighted average price when orders are swept across multiple LPs;
• have wider spreads than its competitors but skews the spread significantly to one side, therefore placing their quotes at the top of the book when aggregating with other LPs;
• quote a tight spread most of the time, but when trading volume picks up they widen;
• jump aggressively to new price levels as opposed naturally progressing to new levels, this causes gaps in charts and throws erroneous prices into the stream, which may trigger resting orders.

News impact

Suppose your strategy is sensitive to short term volatility. In that case, we can pinpoint which LPs can maintain as much consistency as is reasonably possible in terms of liquidity and price. Some LPs are known to quote insanely wide spreads during high impact news events. Often these events are disguised if the LP quotes competitively most of the time but goes insane during certain events or times of the day.

Coverage

The trading pairs offered by each LP should correlate to the instruments traded by the strategy. However, conditions don’t just vary by LP; they can vary by instrument. Some LPs can tick all the boxes for the major currency pairs but can be average on the minors and fall short on the exotics. Or, one LP may be average on most pairs but very strong on one or two exotic pairs. Depending on the pairs you trade, we may have to cherry-pick LPs based on what they offer.

Besides instrument coverage, some LPs can be instrumental during specific periods and less so at other times. Therefore, it makes a case for having LPs that can offer compelling conditions 24-hours a day.

Capital & margin requirements

Capital requirements are a huge barrier, especially for younger funds and money managers. Usually, when it comes to accessing the best forex liquidity, US$ 50,000 won’t stretch very far. In fact, with limited buying power, you may only be able to get a relationship with a tier-three provider that resells already resold liquidity.

Although Scandinavian Capital Markets is not itself a prime broker or an exchange venue, we act as a gateway to those relationships. Instead of having to worry about deploying capital across multiple LPs to access tier-one pricing, you just need to provide collateral to one partner (Scandinavian Capital Markets). This way, with that same US$ 50,000 you can get tier-one pricing from industry-leading bank and non-bank LPs via the LP relationships we’ve curated and maintained over several years.

You may also find that as your fund increases in size, LPs may increase margin requirements. 

Transaction cost analysis

When all is said and done, after trades are closed and settled, we help to go through the transaction costs with a fine-tooth comb. We don’t just consider actual expenses, like spread, swap and commissions. We’re able to analyse the cost of opportunity loss by looking at missed deals, partial fills and slippage. There may come the point where introducing LPs with higher volume fees and can ultimately give better execution, and thus may work out cheaper.

Conclusion

A lot of these metrics can be hard to observe. Many of them will occur over short periods, so as you look at the daily average, all conditions may seem to be great. We concentrate on how LPs perform during periods of stress. This approach often unearths facts that would have been disguised in daily averages.

If an LP has an undesirable characteristic, it doesn’t render them valid or invalid. There will always be a series of trade-offs when building the best forex liquidity feed. By knowing the profile of each customer, and the characteristics of each LP, we can design a completely customised price feed. Not only that, but we can monitor any changes in conditions from what was initially defined. As your strategy changes or the LP conditions change, we’re able to pinpoint what optimisations can be made to improve overall quality. 

To learn more about our custom forex liquidity solutions, reach out to one of our relationship managers.