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Importance of Liquidity in Forex Trading

When a trader first starts trading forex, one of the first benefits they’ll notice is how much liquidity the forex market has compared to other markets. According to the Bank of International Settlements’ triennial report from 2016, daily trading volume was over $5.1 trillion.

Forex liquidity facilitates trade, making it a popular market among dealers. Certain variations in the FX market, however, must be taken into account for liquidity considerations. This article will discuss forex liquidity as well as liquidity risk, with the goal of providing a comprehensive knowledge of how liquidity impacts trading.

Some currency combinations are less liquid than others. In reality, the liquidity of currencies varies depending on whether they are major, minor, or exotic pairings (including emerging market currencies). As traders migrate from major to minor to exotic pairings, liquidity in the forex market dries up.

High Liquidity:

In forex, high liquidity refers to a currency pair that can be bought/sold in big amounts without considerable fluctuations in its exchange rate (price level) – for example, major currency pairings like EUR/USD.

Other important (very liquid) currency pairs to be aware of:

  • GBP/USD
  • USD/JPY
  • EUR/GBP
  • AUD/USD
  • USD/CAD
  • USD/CHF
  • NZD/USD

FOREX LIQUIDITY VS. ILLIQUIDITY: 3 RED FLAGS TO WATCH

An illiquid market will exhibit chaotic movements or gaps from the perspective of a trader since the quantity of buying or selling activity at any given time might fluctuate considerably. Price movement is likewise smooth in a very liquid market, which is often characterised as a deep market or a smooth market. Because it’s difficult to manage risk if you’re on the wrong side of a large move in an illiquid market, most traders need and should demand a liquid market.

Here are three warning signals to keep an eye out for:

1. GAPS IN FOREX TRADING

In comparison to other markets, forex has different gaps. Price gaps may arise in forex, however, if an interest rate announcement or other major news event comes out unexpectedly.

Gaps can occur at the start of the week on Sunday afternoon in the United States. Overall forex gaps are generally less than 0.50 percent of a currency’s value if there is a news release over the weekend.

Due to the ongoing nature of the stocks market, a market that trades 24 hours a day, such as the FX market, is deemed more liquid or simply has less gaps. This gives traders the freedom to enter and exit the market whenever they choose. Because price might surge at the open if overnight news comes out against the crowd’s expectations, a market that only trades for a fraction of the day, such as the US Equity market or the Futures Exchange, would be condensed into a thinner market.

2. FOREX QUICKNESS INDICATOR

Brokers frequently include a “volume” option on the chart, which allows a trader to assess the market’s liquidity. The bars on the volume chart are used to interpret this forex liquidity indicator.

Each volume bar reflects the volume traded during a certain time period, providing the trader with a reasonable estimate of liquidity. It’s crucial to realise that most brokers only show their own liquidity statistics, not the total liquidity of the forex market. However, depending on the size of the broker, using the liquidity of the broker as a metric can accurately represent the retail market.

3. VARIOUS TIMES OF THE DAY PROVIDE VARIOUS AMOUNTS OF LIQUIDITY

Short-term traders, often known as scalpers, should be aware of how forex liquidity changes during the trading day. Less busy hours, such as the Asian Session, are frequently range bound, which means support and resistance levels are more likely to remain from a speculating standpoint. Breakouts and greater percentile movements on the day are more common during the main moving market sessions, such as the London and US sessions.

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