For larger forex brokers, because they have many customers opening trades in both (long and short) directions, they are able to internally offset (“internalize”) much of their order flow.
Internally offsetting the order flow allows the broker to minimize their market risk WITHOUT having to hedge with an external counterparty.
When not all the positions can be hedged, they then hedged externally the excess market risk exposure.
A large customer base allows most large forex brokers to theoretically offset most of their customers’ trades with each other.
This allows revenue to be earned from customers’ transaction fees (from the spread).
So it is the volume of customer trading that drives revenue, not customers’ losses.
For smaller brokers, if they cannot hedge their trade with another one of their customers, they “B-Book” (take the other side of) the trade.
And they will do this up to their market risk limit.
They would hedge externally anything above this limit.
The use of B-Book combined with only externally hedging beyond a certain risk limit provides better order execution.
This allows the broker to immediately execute your trade.
It also keeps latency and its costs to a minimum.
This is because they don’t have to A-Book or STP every trade, which would mean paying the LP’s spread every time.
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