Understanding forex liquidity and volatility

When the forex market was still in its infancy, it was limited to mutual funds, large corporations, hedge funds, and mutual funds. This resulted to lower volatility and liquidity as well. However, the volatility and liquidity have greatly increased in the current forex market due to the increased trading frequency.

For this reason, it’s good to understand the forex market before you open your demo trading account. We will discuss both forex liquidity and volatility in this write-up so that you may understand each better, and learn what strategies to use in each situation.

Understanding liquidity

Liquidity determines the activeness of the forex market. It is based on the number of traders who are actively involved in the market as well as the volume they are currently trading. The foreign exchange market is one of the most liquid markets out there, the reason being that it is traded for 24 hours including the weekends. It is also intense with a massive turnover of approximately $5 trillion turnovers on a daily basis. The liquidity however often fluctuates since financial centers open and closes throughout the day.

Importance of liquidity in the forex market

Since ancient times, liquidity has been an essential factor in trading. A company, person or even a country can quickly become bankrupt if they lack enough liquidity in the assets. The same case applies in the forex market. Below are the benefits of liquidity in forex:

  • A liquid market is logical since it follows the price patterns, support, resistance levels and much more.
  • Forex liquidity minimizes the losses in the market. It also becomes easy to manage risks in the liquid market rather than the illiquid market in forex.
  • Liquid markets follow the crowd behavior which is much easy to read as compared to the unusual behavior.

Tips for trading in the liquidity market

  • Keep reading news- be close to the market news so that you can stay informed of the changes taking place in the forex market. The information you get will also help you decide if you should keep trading or not
  • Look for the help of an expert or forex professional
  • Trade carefully since you investments can easily get lost when the market is very liquid

What is volatility?

Volatility is a measure of sudden the market prices change. The liquidity of the market has an enormous impact on how volatile the prices will be. Usually, a lower liquidity results make the prices to change drastically and therefore causes a more volatile market. Conversely, higher liquidity results to a less volatile market where the prices do not rise or fall drastically.

Importance of forex volatility

  • Increasing volatility makes trading for the investors easier
  • It becomes easy to make profits in a forex market which has an increasing volatility

Tips for trading in the volatile forex market

  • Ensure that you select the most appropriate currency or instrument depending on your volatility tolerance
  • Always have a well-strategized exit plan just in case the volatile market fails to favor you
  • Work along a forex broker who is well conversant with the volatile markets.
  • Don’t panic; follow your strategies. Avoid overtrading and also avoid having too many expectations. Stay calm, be consistent and you will reap maximum profits.

forex liquidityA liquid market such as the forex tends to have smaller increments because their lower volatility is resulting from the high liquidity. For this reason, most traders who trade at the same time experience small fluctuations in the prices. However, a sudden drastic movement can sometimes take place in the forex market. Since most currencies are not usually affected by the sudden or drastic changes in political, social and economic changes, the chances are high that the prices become volatile easily. Potential investors and traders should, therefore, be mindful of the current financial events and also keep up with the news to avoid potential losses.