The Forex market stands as the world’s most considerable financial market, with a daily trading volume of $6.6 trillion. One of its most distinctive features is exceptional liquidity, guaranteeing a continuous influx of traders. This liquidity fuels a market that functions almost round-the-clock on weekdays, offers generous leverage options, and demands low capital entry. These attributes make Forex an alluring choice for both active traders and those with a longer-term perspective, promising exciting prospects.
Liquidity is a measure of how easily an asset can be traded at a price that accurately reflects its intrinsic value. Cash epitomises liquidity as it can be swiftly and effortlessly converted into other assets. In contrast, tangible assets like real estate, fine art, and collectables are relatively illiquid. Financial assets such as stocks and partnership units fall at various points along the liquidity spectrum.
What Makes Liquidity Valuable?
The significance of liquidity cannot be overstated. Thriving trading hinges on a liquid market, underscoring the need for an FX liquidity provider (LP). These providers ensure price stability by taking positions in forex pairs, which can be offset with other market makers or held for future liquidation.
Forex liquidity profoundly influences trading costs and strategies’ performance. A decrease in liquidity leads to increased trading costs, which can markedly affect the outcome of trading strategies. For instance, scalpers rely on highly liquid assets for profitable results, whereas illiquid assets are unsuitable. Even for fully automated trading, those employing the same strategy across all currency pairs may achieve less fortunate results than those upgrading their plan based on changing liquidity conditions.
Factors Influencing Forex Liquidity
Forex liquidity, the ease of buying or selling banknotes and coins, hinges on two main factors:
Supply and Demand: The trading volume directly affects Forex liquidity. Increased trading by market participants, including banks and brokers, provides more chances to match and fulfil orders, subsequently boosting liquidity and narrowing spreads. Several aspects, like economic releases, central bank actions, and geopolitical events, all sway the supply and demand dynamics of the Forex market.
Global Economic Centers: The Forex market functions continually, 24/5. Most trading activity occurs via automated platforms that employ algorithmic trading solutions. Yet, global financial centres’ starting and ending working hours, often aligned with stock market hours, affect Forex liquidity. The overlap of the London and New York markets tends to witness the most significant surge in liquidity, with London being the epicentre of Forex trading volumes, followed by New York.
By grasping these two critical aspects, traders and investors can get more familiar with Forex liquidity dynamics, empowering them to make more informed decisions.
Defining High and Low FX Liquidity with Examples
The basic dissimilarity between high and low liquidity is in trading expenses, depending on the chosen trading strategy. Consider this illustrative example:
Forex brokers offering competitive prices may quote the EUR/USD pair with a minimum spread of 0 pips in a commission-based account, accompanied by commissions ranging from $0.80 to $7.00. In a commission-free alternative, the spread can be as low as 0.4 or 0.7 pips.
Consequently, the expense of trading one standard lot in the EUR/USD can vary from $0.80 to $7.00. However, less liquid currency pairs may have spread more than two pips, resulting in fees exceeding $20.00. For traders frequently executing one-lot trades, a common practice for portfolios under $5,000, trading during periods of high liquidity and avoiding low liquidity periods can save an average of $15 per lot. This leads to earning an extra $300 per month.
FX traders gauge liquidity levels by observing the spread, representing the difference between bid and ask prices. Higher liquidity is linked with narrower spreads, while lower liquidity leads to wider spreads.
Choosing the proper LP is paramount for investors seeking optimal solutions in their FX brokerage. These providers not only offer additional services such as CRM, Backoffice, and necessary integrations but also comprehend the pivotal role of FX liquidity in ensuring successful trading.