The Importance of Liquidity in the Forex Market
Liquidity, as a forex trader you have heard this term right? Since long time ago, liquidity has become the most important factor in the world of investment, including forex. Someone, company or even a country can be very rich if they have investment assets with high liquidity.
As a trader, of course we very often hear about liquidity, especially in times of financial crisis, for example the crisis in 2008. Several large companies declared bankruptcy at that time. They do not have enough liquid assets to pay off creditors. Greece as a country is also in the same position in the last 5 years, where the country’s revenue came from European Union debt loans. If only the European Union does not want to provide assistance to Greece. Maybe this country will default on the payment of IMF debts and officially make Greece a bankrupt country.
Liquidity, able to provide a wealth and able to provide bankruptcy. Liquidity is one of the most important and main elements in the forex market. Let’s discuss this liquidity.
“The most liquid market in the world is the Forex Market”
Before we discuss what liquidity is, let’s take an example. On the roadside at night there were 10 people waiting for a taxi when it was raining heavily. At that time a taxi arrived at the side of the road and happened to be the last taxi to operate. Well you can imagine? . Of course there will be many requests for services between taxis. The higher the bid for the taxi driver when asked to take one of the 10 people. The volume of demand is increasing and getting higher.
Similarly, when it happens to a financial market (Forex). Liquidity can be interpreted as an increasing demand for a product or service. How fast can you sell a car and turn it into cash? How fast are you able to sell items that you don’t like?
Liquidity on financial markets
Liquidity on financial markets is easy or fast a certain instrument can be exchanged for cash. Cash in the form of electronic money or physical money. In the capital market, there are several highly liquid commodities, such as bonds from developed countries or gold futures. Conversely, bonds from economically vulnerable countries such as Greece are difficult to convert into cash.
The same thing also happens in the forex market such as US dollars (USD), Euros and other major currencies.
Signs of Liquidity
Stock markets throughout the world are known as perfect and highly liquid markets, but this is not always the case. When the stock exchange closes, investors are closing their positions and the market is very volatile or even stagnant. If we look at stock market charts such as the Facebook stock chart below, there will be many gaps in each movement. The gap occurs when liquidity decreases or the stock market will close soon.
Although not as often as happens on the stock market, there are also gaps in the forex market. The most common signs of liquidity in the forex market are long candlesticks that occur in a short time. Usually occurs when opening / closing the market or the news / economic agenda with high impact (high effect). One of them happened on January 15, 2014 when the Swiss Central Bank (SNB) made a policy that had a great impact on the CHF currency, especially EUR / CHF.
EUR / CHF or the previous euro and swiss franc currency pair could not break the 1.20 level and fell almost 4 thousand pips in seconds. At that time investors and other traders immediately withdraw funds and buy CHF currencies so that they appreciate.
CHF fall in less than ten minutes.
We can see the chart from EUR / CHF below, where before this pair traded at a very narrow range for a very long time and Boom …! fall in less than ten minutes.
Large volume liquidity causes a strengthening of the CHF currency and causes the pair with the CHF pair to drop. All traders, investors and other market players simultaneously added liquidity to CHF at that time. Financial institutions and major well-known banks also reportedly participated in the trade.
The US dollar is the currency most often traded on global markets, including the forex market. It is estimated that at present most of the trading volume in the forex market is carried out by speculators to look for profit. Speculators and liquidity are two components capable of drastically driving prices in a short time. The last time China, a country that allowed speculators to play with their money markets to increase liquidity for CNY currencies.
The Importance of Liquidity for Forex Traders
In 2013, the average transaction recorded in the forex market reached $ 5.3 trillion every day. This is what makes the forex market the largest market in the world, and the most liquid market to date. So the trading volume is very high and the number of transactions continues to grow every time.
The trading volume on the forex market has passed $ 5.3 trillion every day. By looking at it from the point of view of a trader like me and you, of course this is an attraction of a liquid market such as forex. Of course there are times when prices move with high volatility. Often beginner traders say that prices move because of the influence of an economic news or something else.
Well, of course for those of you who want to gain profit in the forex market must understand how the liquidity starts. For example, when the price touches the resistance / support level and the volume decreases, we can conclude that liquidity will enter the market. Either it will breakout / break that level, or go back and move opposite.