Spreads and liquidity go hand in hand as tight spreads are usually a result of good liquidity. We will be giving reference to the spread and liquidity of ECN environment to illustrate how this works.
What is a spread?
In the forex market the spread is the difference between the buy (bid) and the sell (ask/offer) price. The spread is a mechanism of the demand and supply in the market, or the prices at which participant are willing to transact.
The participants who are essentially liquidity providers include; banks, hedge funds, ECN’s and dark pools.
How is spread determined?
The spread with an ECN broker is made by aggregating our liquidity provider’s order books to show clients a best bid and best offer for each currency pair.
A liquidity provider’s order book will have volumes and rates they want to deal at. By combining these order books we are able to show very tight spreads and very deep liquidity. Deep liquidity refers to the large size and spread of orders for clients to execute their trades on.
In the screenshot below we can see the bids stacked up on the left side of the deal ticket and the offers stacked up on the right side of the deal ticket.
Every single bid in the left column represents a limit buy order from an Markets liquidity provider. The top bid price represents the highest price any of Markets liquidity providers are willing to pay. The number in the white box represents the volume they are offering at that price level, the number in the black box represents the aggregate volume available from that price level. As you move further down the bids you can see that the volumes increase significantly. The same applies for the offers on the right side of the deal ticket.
Liquidity is provided to the market through limit orders from liquidity providers. Aggregating the order books of liquidity providers ensures tight spreads and deep liquidity.
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