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How Does Liquidity Work in FX?

Hi folks,

Another question, this time regarding liquidity in the FX market.

So I’ve been watching the webinars and I’m still trying to understand the difference between the liquidity of an OTC market and a centralised exchange.

With a centralised exchange, am I right in thinking there’s one simple orderbook, and it contains the order of EVERY participant (big and small) and it’s that orderbook that controls where price moves. So in a stock for example, when we see the price go up, we know that’s because on a collective basis by every single participant, there’s more demand for that stock than there is supply.

However with FX, I understand that we can’t be liquidity providers like in a centralised market, we can only be liquidity takers. So the orderbook(s) that dictates the direction of the spot FX price is controlled by the 15-20 large liquidity providers and not from the true supply and demand of traders like ourselves; is this correct?

If it’s only the liquidity providers that always take the other side of our trade and decide how many orders they want to absorb at each level, doesn’t this mean that they technically control price? Say they wanted the EURUSD to drop in price, couldn’t the LP’s just decide to offer really thin liquidity below the current market price so it forces our sell orders to drive price down in order to get filled?

When we see an asset on a centralised exchange going up in price, we know that it’s due to there being more demand than supply on a collective basis between all participants, and therefore showing us the true thoughts and sentiment of every participant as a whole.

However when we see a currency going up in price, can we say the same? Or is the increase in the currency price just due to the LP’s deciding to offer less selling liquidity at each level, thus forcing the price to increase to seek new sell orders? So the FX price isn’t a function of how much the participants like ourselves want to buy or sell, but how much liquidity the LP’s wish to offer?

And if this is the case, doesn’t this mean that the spot price of currencies is at the mercy of the liquidity providers?

It’s a topic I’m quite confused on so any information from you guys would be great - thanks! :slight_smile:


Fantastic questions yet again @MCMTheDawg :clap: :slightly_smiling_face: …you’re on a roll :rocket:

Please find video resources (in the order they should be watched) below that address each of your queries:

  1. OTC Markets & Regulators

  2. Order Books, Types & Exchanges Explained

  1. How does OTC Trading work?

  2. Last Look vs No Last Look

  1. What is the “Market” really?

  2. Understanding Capacity & Toxic Flow

  3. Disrupting the OTC Value Chain

  4. The Chicken & Egg Debate: A vs B vs Hybrid Books

  5. Do CFD’s move the market?

Happy binge-watching! :muscle:


Hi MCMTheDawg

In addition to the great information integracore2 provided. I think you are on the right track.
Due to the massive size on the FX market ($5.3 trillion per day at the last count?) there is no centralised exhange.
However, from what I understand tracking the British Pound for a few years, there are “Liquidity Providers/Partners” of national banks/institutions that physically settle transactions electronically. These OTC dealers may use a single dealer platform or multiple dealer platforms and have different costs for credit spreads and so on so prices can vary depending on these costs.
I think over the years these limited OTC dealers have become so huge that they can now “internalise” most market orders using much improved technology without going to the interbank market to hedge positions. As long as an asset/market has liquidity then “in theory” the market should be efficient.
The thin liquidity you talk about can be seen in an increased spread on an asset at say, next day open or a big news event because they have no matching orders on the other side but it doesn’t mean they can move the price (only the spread). You can see the different spreads from different providers at these same times which demonstrates this.
If price needs to move to another level it is because the institutional order flow is moving it there by using their participants OTC liquidity to get it there for whatever reason they see fit.
Hope this helps a bit…

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