Forex trading, boasting over 6 trillion USD in daily trades in 2023, is the largest market in the world. It is renowned for its liquidity, enabling seamless transactions 24 hours a day, 5 days a week.
What is liquidity in forex?
Beginning with the basics, forex liquidity refers to how easily a currency pair can be bought or sold. In a liquid market, traders don’t need to worry about the absence of a counterparty to trade with, as it always has sufficient buyers and sellers.
How to identify liquidity in forex pairs?
One way traders can gauge the liquidity of the forex market is by analysing the bid-ask spread. This refers to the difference between the highest price a buyer is willing to pay (bid) and the lowest price a seller is willing to accept (ask) for a particular forex pair. A narrow spread typically indicates that there are enough buyers and sellers willing to trade at those prices. It's important to note that spreads usually vary between brokers due to differences in their pricing models and markups.
In the Deriv MT5 platform example below, we can see that major currency pairs like EUR/USD have tight spreads (0.00005) due to their high liquidity, while minor currency pairs such as CAD/JPY have marginally wider spreads (0.019) due to their slightly lower liquidity. Keep in mind that forex spreads generally remain tighter and more stable than other asset classes.
Another way to identify liquidity in forex is to look at trading volumes. When they are high, it generally indicates a greater availability of buyers and sellers in the market, which leads to increased liquidity. Over a 24-hour period, volumes tend to start to increase in the Tokyo session, continuing to trend up in the London session, before peaking in the New York session.
Volumes can be shown on Deriv MT5 charts under Insert > Indicators > Volumes > Volumes as seen below.
Analysing the forex market
Traders interested in forex should keep an eye on both economic data and geopolitical events.
Notably, the release of a country's inflation data is eagerly awaited. Higher-than-expected inflation figures may lead to raised interest rates from Central Banks, attracting traders seeking greater interest income and therefore increasing the demand and value for the currency. Conversely, in the Deriv MT5 platform example below, we can see that lower-than-expected US inflation data implied lower interest rates to the market, making the USD less appealing to investors.
Geopolitical events can also impact price movements in the forex market. Political conflicts and trade disputes between countries may prompt risk aversion in the forex market, causing investors to move their funds to safer assets. Elections can also lead to market volatility, impacting the value of currencies.
Forex trading for you
As the world economy embraces globalisation, events become more interconnected. By closely monitoring these factors and combining them with other trading techniques, traders may increase their chances for more successful trades.
Check out how this highly liquid market works with a free demo account that comes pre-loaded with virtual funds.
Disclaimer:
The information contained in the Blog is for educational purposes only and is not intended as financial or investment advice.
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