As a trader starts trading in Forex, one of the main advantages that comes across is how much liquidity it has to offer. The latest figures are around one trillion and this really does allow for ease of trade. This also makes the market very popular among traders as well. There are however certain variances in the market and these really do need to be taken into consideration. This article will explain the entire concept of Forex liquidity and it will also help to reduce the amount of risk involved as well.
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Why is Liquidity Important?
Liquidity in the Forex Market is very important. It determines the ability for a currency pair to be traded or even sold on demand. If you are trading a currency that is very liquid, this can come with its own fair share of benefits. If you are trading on the availability of the market pair however then you need to base the liquidity on the financial institution. This will get you in or out of the trade or even out of the currency pair that you are choosing. It is important to know that not all currency pairs are liquid. Currencies have a varying amount of liquidity depending on whether they are exotic, minor or even major. This includes any emerging market currencies as well. For example, Forex liquidity dries up a trader’s move and it does this between a huge range of groups.
High liquidity in terms of Forex can be purchased or even sold in many different sizes. This can be done in very large variances. Of course, this does depend on the exchange rate and it also depends on the amount that is being traded as well.
Low liquidity in terms of Forex actually refers to a pair that cannot be purchased or even sold in significant sizes. You can’t do this without having a variance in the exchange rate size. Of course, from a trading point of view, the illiquid market will have a ton of chaotic moves. It may be that you have gaps as well. This is all because the level of buying or selling volume at any moment can change at any time. A high liquid market is also known as a deep market or even as a smooth market. The price action is also smooth as well. Most traders should require a liquid market because it is very hard to manage any degree of risk if you are on the wrong side of a big move on the market.
Gaps when Trading
Gaps in the Forex market can vary depending on the other markets. Price gaps can occur in the market if an interest rate or high impact announcement happens against everyone’s expectations. Gaps can occur at the week opening and if there is a news announcement over the weekend then the gaps are usually around 0.50%. A market that trades 24 hours a day, or even the Forex market is considered to be much more of a liquid market. This is because there are less gaps. This allows traders to exit or even enter the market at their own discretion. The market that only trades for a fraction of the day would be considered thinner and this is because the price can jump up overnight if news happened to considered to be big.
The Forex Liquidity
Brokers often offer what is known as being a volume option. This is on the chart where a trader can gauge the amount of liquidity on the market. This indicator is founded by analysing the various bars on the volume charter. Each volume bar represents the amount that has been traded and it also gives them an approximation of the volume liquidity. Using a broker’s liquidity however can represent the market but this does depend on the size of the broker.
Times of the Day
Short term trades, or even scalpers should be very wary of how liquidity can vary depending on the trading There have been very active hours, and there have also been less active hours as well. This does include the Asian session, and this is often range bound. It is also meaning that support and resistance levels are much more likely to hold in terms of a speculation point of view. The major moving market sessions can include the London session and even the US session. They can be more prone to breakouts and they can also be much larger percentile moves on the day as well.
The time of day that you are likely to see the biggest moves on include the US Morning Session. This is because it does actually overlap with the EU and London session. This accounts for well over 50% of the global volume. The US session alone accounts for 20% of the volume and it is often a surprize when things happen.
The relationship between reward and risk is nearly always proportionate. You have to understand the risks involved in a trade if you want to be able to take this into consideration. One main example of how liquidity affects the risk in the market is the crisis that happened with the Swiss Franc in the year 2015. The Swiss central bank came forward and they stated that they would no longer be preserving the Swiss Franc against the Euro. When this happened, the interbank market broke down and this is because they could not price the market. This also led to the retail client account balances for those who traded on the CHF and it also led to account balances to being largely affected as well. Even though these Black Swan effect does not happen very often, when it does, it is incredibly devastating.
Retail forex traders can help to manage this liquidity risk by lowering their leverage and they also make use of guaranteed stops. The broker is obligated to honour these liquidity risks by taking into account the stop price level. When you weigh up the options between liquidity risks and the reward should not be overlooked either. It really should be included as part of the trader’s own analysis routine. The market has evolved over quite some time and if you want a summarized account of the most important developments then this would really continue to shape the market.