Liquidity Reduction - Overview
Liquidity Reduction is a judicious response to liquidity abuse / nefarious trading which protects against where clients are consuming liquidity faster and ahead of our published book. This is a fair, regulator friendly alternative to slippage as it doesn't apply blanket "markup" across all orders.
Some brokers slip everything a client does. Clients have a right to be more annoyed if there's passive markets and they are getting slipped vs judicious and fair application of LR.
We support the option of turning liquidity reduction off for certain clients, or limiting the $/M LR that can be applied.
If there is a client complaint, there is always a solid narrative as to why the liquidity reduction was applied and a justifiable data point narrative, which can be backed up by Echo views to demonstrate what was going on.
Learn more about how to apply liquidity reduction here: Liquidity Reduction - Tuning
Compass supports the application of different types of Liquidity Reduction
- Channel => protection against EA (Expert Advisors), Signals, Collusion, coordinated trading (for coordinated trading between counterparties within the channel). Unexpected market moves. Slippage when liquidity is consumed faster than the published rate. Different distribution channels can have different levels of LR, where one channel price is widened another will not.
- Global => tracks the total quantity across all flow consumed across all channels, model widening will occur across the system.
- Counterparty => avoid the machine-gunners hoping to get TOB spread for large orders
- External Sweep detection => Protects against dealing not full. Signal based liquidity reduction based on the detection of sweeps from elsewhere. Sweep Detection
Global/per channel level
Liquidity reduction applied at the global or per channel level adjusts the published rate and so will impact the spreads published on the model. This is particularly useful over periods of high activity or coordinated trading.
Counterparty Level
Some clients machine gun orders through. Instead of sending in a single order representing all trade volume they want to get done in a short interval, they split that order into a series of small orders. The hope from the client is that they get filled at the top of book price vs the full volume weighted price.
Liquidity reduction at the counterparty level keeps track of a window of volume that the client has done and instead fills orders at a fair price, this applies to the executed price instead of the published rate, note that where this will not affect your published spreads, it can appear as slippage to the counterparty.
Coordinated trading via EAs / Signals / Following.
Lots of orders arriving at the same time pushing the market, particularly in sensitive instruments or illiquid times of day. Based on collusion / EAs / Signals, price is made worse during such coordinated trading.
See more Nefarious Pricing & Trading
FAQ
Question: Why can't I just use slippage / markup to punish the bad guys that classifier finds?
Answer: Some brokers slip everything a client does. Clients have a right to be more annoyed if there's passive markets and they are getting slipped vs judicious and fair application of LR. Particular when handling client complaints. LR will provide a good and fair narrative. A regulator may punish sustained, unfair, always-on slippage
See how to tune liquidity reduction here