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Unlocking the Benefits of Liquidity In Forex Trading
Article Summary: Forex liquidity is confusing to the new trader. How can a market be seemingly volatile and liquid at the same time? This article will be a primer to understanding just that.
As one gets started in forex trading, one of the first benefits they’re likely to hear is how much liquidity the FX Market offers over other markets. The latest figures are roughly $4 Trillion in daily volume as per the Bank of International Settlements. But what does that mean to you and your trading?
Why Should You Care About Liquidity?
Ask anyone during the 2008 credit crisis who was trying to sell their home what are the benefits of liquidity? Or maybe a stock trader who is on the wrong side of a trade when it’s been announced that the stock they’re shorting is rumored to be acquired by a much larger company at a premium in afterhours trading. These people were at a financial stronghold because they could not exit their trade when they wanted to and were subject to illiquid conditions in the market.
Liquidity by definition is the ability of a valued item to be transferred into currency on demand. When you’re trading currencies or Foreign Exchange, you’re trading a market that is by itself, liquid. However, you are trading based on the available liquidity of financial institutions who get you in or out of the trade of your choosing.
What are the Signs of Liquidity & Illiquidity?
From a trader’s point of view, an illiquid market will have chaotic moves or gaps because the level of buying or selling volume at any one moment can vary greatly. A highly liquid market is also known as a deep market or a smooth market and price action is also smooth. Most traders need and should require a liquid market because it is very hard to manage risk if you’re on the wrong side of a big move in an illiquid market.
Learn Forex: Illiquid Vs. Liquid Market
FTSE 100 Index - Equity Markets Are Prone to Gaps
(Created using FXCM’s Marketscope 2.0 charts)
Forex Has Many Liquidity Providers Around The Clock
(Created using FXCM’s Marketscope 2.0 charts)
A market that trades 24 hours a day like the forex market is considered more liquid because you can enter or exit a trade at your discretion. A market that only trades for a fraction of the day like the US Equity market or Futures Exchange would be condensed a thinner market because price can jump at the open if overnight news comes out against the crowd’s expectations.
Are There Gaps When Trading Forex?
Gaps in Forex vary compared to other markets. However, price gaps can occur in Forex if an interest rate announcement or other high impact news announcement comes out against expectations. Also, gaps can occur at the week’s opening on Sunday afternoon in the US if there is a news announcement over the weekend but overall, gaps in Forex are usually less than a %0.50 of a currency’s value and orders can be sent in for execution whenever the market is open and you’ll be filled as soon as the liquidity provider has a price for you.
Different Times of Day Offer Varying Amounts of Liquidity
If you’re a short term trader or scalper, you should be aware of how liquidity in Forex varies through the trading day. There are less active hours like the Asian Session that is often range bound and easier to trade from a speculation point of view. The major moving market sessions such as the London session and US session are more prone to breakouts and larger percentile moves on the day.
The time of day that you’re likely to see the biggest moves are the US Morning Session because it overlaps with the European / London Session which alone accounts for roughly 50 %+ of total daily global volume. The US session alone accounts for around 20% and in the US Afternoon, you will often see a sharp drop off in aggressive moves except for when the Federal Open Market Committee (FOMC) comes out with a surprise announcement which is but a few times a month.
Closing Thoughts
If you’re new to the forex market or maybe you’re coming over from a less liquid market, you’ll be pleasantly surprised by the liquidity. You’ll be able to trade around the clock and the liquidity that provides smooth price actions makes for good technical analysis. Whatever your back ground, building a trading plan in this market can conform to you and your availability much better than most markets.
Happy Trading!
---Written by Tyler Yell, Trading Instructor
To contact Tyler, email tyell@fxcm.com.
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