Liquidity In Forex Trading

Hello traders,

Back again with Finex’s educational article that dissects trading terms, especially the Forex trading.

This article is part of the Finex Glossary.

Check here for more discussions about terms in Forex trading.

Liquidity in Trading

This time Finex will discuss liquidity in Forex trading.

Of course, those of you who have been trading for a while have heard of this terminology.

Those of you who are just starting to trade may not have. But it’s time for you to learn one of the terms that are often circulated in the trading world.

So, what is liquidity?

Liquidity in foreign exchange (forex) transactions is viewed as the ability of a currency pair to be bought and sold without causing a major impact on its exchange rate.

A currency pair is considered to have a high degree of liquidity when it can be bought or sold easily, and there is a large amount of transaction activity for the pair.

Usually, liquidity is calculated by taking the transaction volume or the volume of transactions currently pending in the market.

Liquidity is a key factor to be able to make profitable transactions. Greater liquidity in financial markets eases the flow of transactions and makes prices more competitive.

It can be concluded that liquidity in Forex trading allows traders to easily make transactions, thereby affecting the popularity of a market.

Liquidity Characters

Not all currency pairs are liquid.

Currency pairs tend to have varying degrees of liquidity depending on whether they are major, minor, or exotic pairs (whether they are emerging market currencies). Forex liquidity can recede, for example when traders move from major pairs to minor pairs, and finally to exotic pairs.

Liquidity also has the peculiarity of measuring how quickly an asset buyer can convert cash into tangible assets.

In a highly liquid market, a person who wants to buy an asset that has a fundamental value of $100 will be able to buy that asset instantly for $100, and he/she receives the asset instantly.

Liquidity has a large impact on the level of market volatility.

Lower liquidity usually results in a more volatile market and has the potential to cause prices to change drastically.

Meanwhile, higher liquidity usually creates a less volatile market where prices do not fluctuate drastically.

Volatile markets generally occur when the market rises and falls more than one percent in a day over a sustained period of time.

High Liquidity

Considerably high liquidity can be seen from currency pairs that can be bought/sold in significant sizes without a large difference in exchange rates, for example in Forex trading, major currency pairs such as EUR/USD.

Other major currency pairs that are considered highly liquid are:

GBP/USD

USD/JPY

EUR/GBP

AUD/USD

USD/CAD

USD/CHF

NZD/USD

Low Liquidity

Meanwhile, low liquidity in forex refers to currency pairs that cannot be bought/sold in a significant measure without large variations in their exchange rates, for example, exotic currency pairs such as PLN/JPY.

The Importance of Liquidity in Forex Trading

If the market is not liquid, it will be difficult to sell or convert assets or securities into cash.

For example, you have an asset that is very rare and of very high value. Let’s say you set a price of Rp5 billion. However, if there is no market (aka no buyer) for your assets, then your assets are irrelevant because no one is willing to pay.

This means that your assets are highly illiquid.

You may need the services of an auction house to act as a broker and track down potentially interested parties, which can be time-consuming and incur costs.

Liquid assets can be easily and quickly sold, and cost very little.

Learn the fees that are charged to traders for each transaction made.

From the corporate side, a company must have sufficient liquid assets to cover short-term liabilities such as bills, and payroll expenses, or to deal with a liquidity crisis, which can lead to bankruptcy.

Have you got the benefits you were looking for?

We hope so because we are always trying to provide important trading insights for those of you working in this field.

Profit for you is our inestimable satisfaction.

Frances
Frances
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