What do brokers, traders, and liquidity providers do?

What do brokers, traders, and liquidity providers do?

Brokers, tradings, liquidity providers
Photo by @mikeygl

Brokers, Traders and Liquidity providers form, with the various trading exchanges, the bedrock of the trading infrastructure. 

In this lesson from the Trading Gym, we’ll look at each of these participants and consider the part they play in the trading process.

What do market participants do?

An “market participant” is an economic agent or decision-maker involved in the economy. Buyers are agents on the demand side when they borrow money to buy financial instruments and sellers are agents on the supply side when they provide capital in the form of investments.

But as well as traders and investors who buy and sell financial products in a structured market, banks, primary dealers or financial institutions play a big part in the capital and money markets.  

Banks often take an active role in capital markets through the bond markets. Primary dealers trade in government securities (like bonds) in primary and secondary markets. And financial institutions may provide long term funds, for example, in industry and agriculture.

Many people think of brokers in terms of insurance policies or mortgages – someone who can sort out the best deal for you. In the financial markets we think of them simply as deal makers. 

Brokers sit between your order and the marketplace in the online trading industry. Their responsibility is to access the requisite trading exchange for you as quickly as possible so that your order can be fulfilled at the best possible price for your benefit.

Traders can be small retail forex traders operating a micro trading account, or a trader from an investment bank exchanging a $200 million order from a client in the USA for euros – and everything inbetween.

Liquidity providers and market makers provide liquidity (funds). These lubricate the financial ecosystem enabling transactions to take place quickly and smoothly.  

The job of the broker

Brokers are middlemen who ensure that transactions between buyers and sellers are fully completed. They execute client orders and, by encouraging liquidity, reducing the bid-ask (buy-sell) spreads and increasing transaction volumes, they help to improve market efficiency.

Some financial brokers also conduct research and source market intelligence to assist investors and traders with their investment and trading plans. Some may also offer other financial products and services through their brokerage, such as access to private client services.

Those brokers who work for retail clients in the financial trading industry are typically either forex brokers or stockbrokers. Their job is to execute client orders by getting them into the relevant exchange to be matched. Brokers make their money by charging fees for buying or selling financial securities such as stocks or forex pairs  including applying a spread charge or commissions.

The business of a forex brokerage is to connect retail forex traders with the forex market. Trading takes place on the interbank market, where banks trade currencies electronically at prices that vary from bank to bank. Your broker works as an intermediary between you and the interbank system and he makes it easy for you to buy or sell a currency pair.

Before forex brokers found their niche in the marketplace, individual traders and investors wanting to trade currencies needed to have a large bank account and a strong relationship with a bank. The bank would then help them to access the forex market.

What do market traders do?

A financial market trader may work for themselves or for a firm, buying and selling securities like stocks (shares). They may also trade in bonds, forex currency pairs, commodities and other financial instruments such as cryptocurrencies. Their aim is to make profits by taking advantage of price fluctuations on individual financial products.

Forex traders and stock traders tend to have slightly different strategies. A stock trader, for instance, is more likely to plan longer-term will probably buy and hold stocks in companies quoted on stock markets. Forex traders are more likely to be day traders who will buy and sell currency pairs daily, but won’t hold positions in the forex market overnight.

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How to be a market trader

It’s not difficult to become a market trader in the financial markets. YOu find a broker, open an account and start learning. We in the Trading Gym suggest that there are four important stages:

Open a Trading Account

  • Find a good online broker and open an account. 
  • Familiarise yourself with the features and benefits of the account and the associated trading platform
  • Take advantage of the free trading tools and research offered exclusively to clients. 
  • Use a virtual trading (demo) account to begin with until you are ready to trade live with your hard-earned money.

Take a crash course in market information

  • Educate yourself. Read your broker’s reports, participate in webinars and read the financial media.
  • Don’t assume because you’ve read about the market on Monday, the same will hold true on Tuesday. It won’t. The markets are constantly changing so you should be constantly reading and learning.
  • Consider subscribing to any free newsletters from major financial publishers. 
  • Work through the CALUSO Trading Gym lessons and refer to them as you need to as a refresher. 

Understand financial analysis

  • Become familiar with the basics of technical analysis by studying charts – endlessly! You’ll need this to become proficient at price prediction. 
  • Don’t make assumptions about prices. Remember they can go down as well as up and do both alarmingly quickly.
  • Set aside time to understand fundamental analysis. You need to know what factors affect the markets you trade and be on the ball when it comes to the timing of key news releases and data publications on your economic calendar. (eg. the results announcements of a key FTSE 100 company) 
  • Remember that key financial events may be ranked from high impact to low impact. For instance, if the U.S. Fed central bank lowers its interest rate, it is high impact. It can have a major and immediate effect on the U.S. dollar, the price of commodities (priced in dollars), and equity indices.
  • Don’t pay lip service to technical and fundamental analysis. Be ready to put them into practice in your own trading.

Practice Trading

  • As a retail trader, you are usually offered the chance to practice, free of charge, before you go live. Take it!
  • Practice on a virtual or demo account for as long as you need to ensure you have properly learnt the basics of financial trading. 
  • Typically you’ll get around $10,000 virtual units in your demo account to experiment with. It will help you familiarize yourself with your broker and with a trading platform like MT4. 
  • When you’re ready to move to live trading do it with small amounts of your funds until you feel comfortable increasing your stakes. Remember, never trade with sums you cannot afford to lose.

Where do traders buy their financial products?

You, as an individual retail trader, buy your financial products from (and through) your broker. Your broker is able to access markets you can’t. For instance, your forex broker might access the interbank market to obtain the currency pair quotes you need. You are most unlikely to have the funds to do this yourself.

When you are ready to make a forex order, your broker will probably place it into an ECN (electronic communication network) where millions of buy/sell orders are matched every second. This is not something you can do yourself. 

Similarly, if you want to trade stocks, your stockbroker will obtain quotes for the stocks you want to buy, usually at better prices and lower costs than you could obtain by dealing directly. You buy the stocks from a stock broker who buys the stock on your behalf from the market. 

Today, human stockbrokers are less in demand than they were though there are still times when investors rely on stockbrokers to execute trades especially when they are not straight forward. This might, for example, be if an investor has multiple transactions they need to execute in a particular order.

What do liquidity providers do?

A liquidity provider can also be a market maker. They provide financial lubrication to the trading environment and make markets in various financial products. Market makers may be companies or individuals who quote, buy and sell prices in financial instruments or commodities. They aim to make a profit on the bid-ask spread, or they charge commissions. 

It is because the liquidity provider acts as both the buyer and the seller of a particular asset that they can make a market. And many stock exchanges appreciate having liquidity providers who commit to providing liquidity for specific stocks.

What is the process in trading?

By now you should know which markets you can and want to trade online. You may sometimes hear the terms ‘front, middle and back-office functions and it is worth briefly spelling out how these fit into the trading process. Remember of course that we are not talking physical offices here, this is all about different elements of electronic trading.

  • Order initiation and delivery is a front-office function
  • Risk management and order routing is a middle-office function
  • Order matching and conversion into trades is a front-office function
  • Affirmation and confirmation is a back-office function
  • Clearing and settlement is a back-office function

Clearing, settlement and custody are words we’ve not used much to date so here is a brief explanation:

  • Clearing happens when a trade is successfully matched in the system.
  • Settlement occurs when the title of the financial instrument passes from the seller to the buyer.
  • A custodian undertakes the safekeeping and administration of the trade on behalf of issuers and investors.

Obviously the purpose of every trade is to complete it at the best price, with the least risk and at the cheapest cost.

Moving on

In our next lesson we will look in more detail at the specific choices you will have to make concerning the products you want to trade. 

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