What Is a Net Open Position, And How Do You Deal with It As a Broker?

For the average trader, placing a buy or sell order entails simple clicks and keeping track of the position. However, on the backside, there are several mechanisms that hold the system intact, safeguarding market participants and providers from unexpected risks.

The net open position is a crucial component of the broker-LP relation, allowing the brokerage firms to increase their efficiency while ensuring the capitalisation of liquidity providers without exposing them to risks.

NOP is a critical term that many brokers and trading providers miss out on, putting them and their clients in unfavourable situations. Let’s explain the net open position formula and what affects it.

The net open position is the limit the liquidity provider gives to a brokerage company, using which it can execute short or long positions and market orders. It can be denoted depending on the subject asset class, whether Forex, commodities, stocks, or other markets.

It is one of the main determinants of the relationship and financial agreement between the broker and the liquidity provider, mostly impacted by the limits implemented by the prime broker.

The FX net open position is the maximum USD notional amount a broker can use as a market order within a particular liquidity provider. The NOP limits are determined by the collateral placed with that specific LP.

This agreement decides the type of margin trading allowed by the broker when trading with leverage, besides other specifications, such as the initial margin requirement and maintenance. 

To understand how NOP limits work, let’s discuss the following example. If a broker collects short positions on a consolidated basis and sends 1,000 lots of gold, each lot equals 100 ounces. 

This means that the broker is sending an order of 100,000 ounces to the open market, multiplied by the current market price of gold at that very moment.

Let’s say the price of 1oz gold = $2,000. This means that the position involves executing $200 million worth of gold within that LP. However, such a transaction will most probably exceed the maximum net open position set by the liquidity provider, leading to order rejection since it does not fall within the agreed NOP limit.

LP and prime brokers (PB) set these limits to protect themselves from sudden market shifts caused by massive trading positions. Additionally, this safeguards them from manipulation and ensures stable liquidity flow to other brokerage companies.

These limits also benefit the retail broker by preventing them from increasing their exposure to unexpected risks coming from executing significant amounts, especially when trading with CFDs that do not require the trader actually to own the asset.

Liquidity providers set NOP limits as a result of the threshold applied by PBs, leading to the LP putting a limit on the broker. Ultimately, this ensures the provider keeps steady streams of liquidity and stable flow with the prime broker.

Otherwise, liquidity providers would just give brokerage companies uncapped order limits, including margin trading, which leads to inefficient financial systems and chaotic market access and liquidity flows.

Thus, when the LP increases the limits and decreases the margin requirements, it helps the broker improve its efficiency and process more orders. This way, the LP uses its funds to cover the gap between the broker and the trader when it comes to initial margin and collateral.

Liquidity providers carefully set their limits using rigorous net open position calculations to safeguard their funds. However, it is a dynamic concept that is affected by the following factors.

The net open position limit is not an entirely fixed mechanism. Today, most LPs use a dynamic NPO limitation that changes according to the market conditions. For example, the limits during the working days are different than NOP limits on the weekend, after-hours trading, etc.

Additionally, during market uncertainty and unexpected events, LPs decrease the net open position caps to mitigate additional risks coming from market instability and extreme volatility.

The net position is an order limit imposed by the liquidity provider to brokerage companies, determining the maximum USD amount that can be executed within a particular liquidity provider.

The NOP is determined in agreement between the broker and the LP and stems from the order limitation applied by prime brokers. Ultimately, these limits are inserted to safeguard the market from increased exposure and ensure stable liquidity for market participants.