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All You Need to Know About Liquidity

12:58 PM Jan 17, 2020
1038
For beginners

If you read at least one article describing the benefits of Forex then you probably already heard about the “high liquidity” of the currency market. But for a novice trader, these are just empty words. How do you know that high liquidity is an advantage if you don’t understand the actual meaning of the term?

It's time to talk about this concept and tell you what time it is best to open and hold your trades considering the level of liquidity in the market.

What Is Liquidity

I could give you an abstruse economic and historical excursion and talk about the origin of the word itself and its application in various fields. But I would better explain this term to you in a simple and understandable manner.

Liquidity is basically the level of supply and demand. With a high level, you can quickly sell or “liquidate” any goods. In Forex, you can easily trade currencies even in large volumes and be sure that you will easily liquidate your position at any moment. That is why a high liquidity level in the currency market is considered an advantage

The Impact of Liquidity in Forex

So, we already know that a high level of liquidity allows us to liquidate large trading positions. The speed with which instruments are bought and sold on the market obviously affects the price movement. Therefore, the level of liquidity on the Forex affects volatility. So basically, the way price moves on your charts often depends on volatility:

  1. With high liquidity, the chart moves smoothly, without sharp jumps.
  2. With low liquidity, the market behaves erratically and you can often experience slippage and gaps.

Remember though that the impact is not always direct. It happens that with high liquidity there is low volatility in the market, and vice versa.

Pay attention also to the major economic news releases. Even with high liquidity, they can cause sharp jumps on the charts. During these periods, many market participants don’t want to risk their capital and try to avoid trading, which provokes a drop in supply and demand and a further decrease in liquidity.

About Liquidity of Different Instruments

Forex is the most liquid market as money will always have a high demand in the world. Every moment, people exchange it for various goods. That’s why currencies always have a high demand. Not surprisingly, Forex trading volumes are measured in trillions.

The most demanded currency in the world is the US dollar. About 62% of the total transaction volume contains the USD. That is why major currency pairs are the most liquid in the market and you are unlikely to find yourself in a situation where you simply cannot liquidate your position.

Liquidity in Different Periods of Time

Liquidity levels vary throughout the day. Of course, there are many influential factors but usually, the least liquid trading session is Asian. The increase in demand is observed closer to the London session. It holds through the New York session and declines towards its end.

Considering these indicators, the European and American sessions are the best time to trade. The chart at this time moves smoothly and most often has a more precise direction, which means that the market has lower chances to go flat.

The liquidity level is greatly reduced after the closure of all trading sessions. The market begins to behave unpredictably and the level of risk rises significantly. That is why day traders never leave their positions open at night. The chance that the volatility will sharply increase and, as a consequence, you will lose a huge part of your capital is too high.

The season also affects liquidity. At the end of summer and before the New Year holidays, the demand for currency is sharply reduced. There are far fewer market participants. Such a market is called “thin” and “weak”. Some major Forex players love using this “weakness” to their advantage. As there is a small number of open trades, they often easily manage to reverse the market in their favor. Partially because of this, many regular Forex traders try to avoid trading during these periods.

Disadvantages of Low Liquidity

With low demand for currencies, trading conditions often get worse. It happens as usually during low liquidity the spread widens. If you trade on a floating spread, you should try to open your trades during high liquidity periods.

High demand also affects the speed of order execution. The lower the liquidity, the slower orders are executed and the higher the chance of requotes.

To Summarize

What did we learn today? High liquidity gives us a number of advantages:

  • The market moves more smoothly, without slippage and gaps
  • Spreads and requotes are lowered
  • Order execution speed is higher

You could say that you should avoid trading during periods of low liquidity. To do this, it is better not to open trades during the major economic news releases, trade mainly in the London and New York sessions, and also try to avoid trading during the periods before large holidays, as well as in late summer and before the New Year.

It seems that these are all conclusions for today. I hope the term “liquidity” has become a little clearer to you and you can apply this knowledge in trading to improve your performance.

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trading mindset beginners novice traders trading strategy forex trading trading plan broker losses forex mistakes trading habits women in Forex female traders risk management profit trading instruments pairs price advantages of forex leverage FXCL investments copy trading advantages of Forex social trading professional traders trading psychology demo trading buy/sell bid/ask spread Metatrader 4 market analysis technical analysis fundamental analysis trade trading platform Forex trading novice trading dealing with losses charts timeframe indicators MetaTrader 4 trading routine support level resistance level trend low-hanging fruit stop loss loss trading history long-term goals open trade close trade daily charts swing trading intraday trading scalping trading setup Forex traders bullish bearish resistance support MA 200 trend trading professional trading EMA EA daily chart weekly chart Forex news highs lows account type cent trading Mini Micro Cent Partnership commission fees trading terms Stop Loss news trading economical calendar major news release currency pair currency rate national currency trading journal trades profit/loss emotions news release positions size Expert Advisors platform trading robot cryptocurrency volatility day trading position size lot account types cent accounts Mini account ECN Copytrade ECN accounts swap-free minimum deposit order execution liquidity providers demo accounts real account low-risk trading EUR/USD economic calendar majors cross-currencies exotic currencies base currency quote currency quotes bid ask Brexit United Kingdom European Union GBP Euro GDP WTO price levels moving average 4-hour chart 1-hour chart bulls bears false breakout cross-currency USD price action pin bar trading inside bar trading hands off breakeven stop loss 50% stop loss pin bar high-frequency trading position trading swings breakout strategy trading style Entry order Take Profit hammer shooting star inside bar pinocchio bar head and shoulders harami risk to reward ratio trading calculator trader’s age emotion control stop-hunting false signal trading session New York session Asian session non-farm payrolls fed rates decision central banks mentor teacher Forex education Forex books candlesticks bonuses tradable bonus no deposit bonus deposit bonus cashback pending orders counter-trend trading risk-to-reward ratio 1-2% rule uptrend downtrend news releases slippage emotional trading stop orders limits orders trailing Stop correlation Correlation Matrix EURUSD EURJPY RSI Overbought/Oversold indicator doji morning start candlestick pattern liquidity London session gap requote US dollar greed excessive trading Expert Advisor trading instrument Twitter Trump euro canadian dollar japanese yen mexian peso currency pairs Fed China economic news currency wars USA interest rates trade agreement H1 H4 D1 sell trade buy trade price level trading system checklist Default mode network Nonfarm Payrolls intraday traders lot size Stop Out margin breakeven pip point entry price chart candles weekly candle daily candle engulfing candle Doji W1 Coronavirus epidemic macroeconomics markets CNY Bitcoin gold Jerome Powell fears money management trading signals Charles Dow Dow theory primary trend Relative Strength Index signals market noise trading volume oversold/overbought corrections candle M30 GBPUSD GBPJPY pending order fundamentals Interbank order Stop order Limit order Standard account Interbank account liquidity provider M5 chart XAUUSD Chinese yuan flat US Dollar Fed Interest Rates inflation level XPTUSD platinum XAGUSD silver USDCNY Chinese Yuan instruments swap trading hours Buy Stop Sell Stop Average True Range ATR range sideways range price level trading scripts Excel tables entry point equity balance applications highs and lows RSI Fibonacci terminal server proxy OS Windows XP self-trading Forex advantages gap trading Fibonacci levels USDJPY Buy Limit Cherry Blossom market cycle mark-up mark-down consolidation distribution long positions short positions double bottom triple bottom double top triple top pattern signal presidential cycle Elliott wave Kondratiev wave