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I'm still confused on how to provide liquidity on the forex market using passive or resting orders and get the spread from that (selling at ask and buying from bid) And what's the dynamics on the LOB using them.?

Anything that could lead me to this will be appreciated. Thanks

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    $\begingroup$ To me it is very unclear what you are asking. $\endgroup$ – noob2 May 26 '17 at 14:04
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The only way you can use limit orders to provide liquidity is to post prices that are the same as the prices of the limit orders, and then you will not be earning any spread. In other words, what you are asking is not possible, since to earn spread you would have to quote a bid that is lower than the price of your client's limit buy order, or an offer that is higher than your limit sell order. This of course runs the very real risk that the client will not get filled on their order, when had their non-discounted interest been advertised to the market, they might have been filled.

Therefore, doing that (spreading the client's order) would be unethical, since you would not be exposing the client's true interest to the market, but rather a discounted interest (unless there exists an explicit understanding between you and your client that you would be acting in this manner). The client has placed their trust in you to execute the order faithfully, and instead you are using the client's interest to earn risk-free profit in a way that jeopardizes their order's execution.

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With a resting order the market maker's client takes (buys) at the offer, or gives (sells) at the bid. The market maker prices the deal that way as with any other order type. A resting order is simply another type of order and the client pays the market maker's spread like with any order type. I am not sure I agree with @CPL593H if you're a market maker and have a client who will trade at your spread (rather than with someone else) then that's the client's choice. In fact resting orders are a service provided by the market maker so the client doesn't have to watch the market for the prices they want. I don't think the market maker has any obligation to disclose client resting orders to anyone else. In fact they are obliged not to by client confidentiality. Then if a resting order is filled the client has a right to an explanation of the price they received. It will be the same as if it was any other order. If there's a "risk free" profit that's like for any other order because the market maker can immediately cover in the interbank market where the minimum deal sizes are $1 million or above and the client may not have that amount to trade or access to those markets. I mean that is how the industry works. The client pays a spread to cover hedging costs, market access costs, regulatory reporting costs, and any other such costs the market maker has to bear (otherwise the client would have to pay for all these)

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This paper Limit Order Strategic Placement with Adverse Selection Risk and the Role of Latency (by L and Mounjid) is probably exactly what you expect.

It is explained how (given a model of orderbook dynamics close to the Queue reactive model) to decide to cancel or not a limit order with respect of the state of the bid and ask queue sizes and your position in the queue.

In short:

  • if you are on the weak side of the book, you should rather cancel (to fear adverse selection)
  • and you are on the strong side, you should stay (and possibly have a good rank in the queue).

Statistics are provided using real data from nasdaq-omx (nordic European equity markets), on which you have the name of the owners of executed orders, hence real data give clues on the different behaviour between HFT, banks and brokers.

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The first response is wrong, you can do this providing the venue is operating a central limit order book and you can match with their client flow. There are several venues or liquidity pools that allow this. If your limit order is at the top of book and someone wants to trade at that price then you will be filled at your price. Making money purely from the spread in FX isn't easy as it is a highly fragmented market and you are relying on the ability to exit your position before the market moves against you. Most market making strategies are using some sort of short term price prediction unless you can get access to really soft flow. Plenty of people are doing what you describe and making nice money, not millions but a good income. If you want to go beyond that you really need some alpha strategies built in.

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