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The higher forex market liquidity than other marketplaces is one of the first advantages a broker will likely notice while engaging in forex trading. According to the 2016 triennial report of the Bank of International Settlements, the most recent estimates show a daily traded volume of approximately $5.1 trillion. Traders favour the market due to the convenience of trading made possible by FX liquidity. But for the sake of liquidity, some FX market variations must be considered. To give readers a comprehensive grasp of how liquidity impacts trading, this article will define the terms “forex liquidity” and “liquidity risk.”
What Is Forex or FX?
The global exchange market for exchanging one country’s currency for another is the foreign exchange market, or Forex or FX. With trillions of dollars transacting hands daily, the currency market is the largest and most liquid globally. It is not centralized, and no government agency is in charge. An electronic network of banks, brokerages, and individual traders instead makes up the FX market.
What Is Liquidity?
When a security or financial asset may be swiftly and readily turned into cash without losing value, this is referred to as having liquidity. Cash alone is the most liquid of all the assets. In other words, the degree to which an asset may be swiftly purchased or sold on the market at a price representing its underlying value is referred to as liquidity. Cash is considered the most volatile asset by the liquidity provider since it can be quickly and easily converted into other assets. Real estate, fine art, and collectables are examples of tangible goods that are all rather illiquid. Other financial assets fall at various points throughout the liquidity spectrum, from stocks to partnership units.
Reward Vs. Liquidity Risk
Understanding the risks associated with trade is important since, in the financial markets, the risk you take is roughly proportional to the profit you get. The 2015 Swiss Franc crisis is a prime illustration of the volatility threat in the currency market. The interbank market collapsed due to the central bank’s statement that it would no longer maintain the peg of the Swiss franc to the euro. Due to this, brokers were unable to provide CHF liquidity. Prices for EUR/CHF were far outside the prior range as interbank pricing, and the foundation of FX pricing resumed.
This significantly impacted retail buyer account credits for individuals trading CHF. Despite being uncommon, these “Black Swan” occasions are not unheard of. Retail forex traders should reduce their leverage or employ guaranteed stops, where the broker must honour your stop price level, to manage these liquidity risks. Liquidity risk and reward comparisons shouldn’t be disregarded and should be a regular element of a trader’s analysis process.
The international currency exchange market is called the forex, or FX. As a result, it establishes how much one currency is worth compared to another in the real world. The amount of money a traveller receives when exchanging one currency for another is determined by forex rates. Forex rates also impact global trade since businesses that purchase or sell internationally must factor currency swings into their cost calculations. The foreign exchange liquidity market inevitably affects consumer pricing by raising or lowering the cost of imported components.