What Exactly is Liquidity and Volatility In Forex Trading?
Forex liquidity allows for ease of trade, as a trader gets started in forex trading, one of the first advantages they’re likely to come across is how much liquidity the forex market offers over other markets. The figures are roughly $5.1 trillion in daily traded volume as per the Bank of International Settlements triennial report of 2016.
However, certain variances in the FX market need to be taken into consideration for liquidity purposes. This article will explain the concept of forex liquidity as well as volatility, ultimately seeking to provide an overall understanding of how liquidity and volatility affect trading. Forex is one of the most popular markets for trading in the world today. When used correctly, investors can access the landscape to make quick money by trading currencies when slight changes happen in the geographical environment. While there are a lot of things that make this type of trading beneficial, from its relatively low learning curve to its ability to offer a range of ways to build your cash, many experts recommend Forex because of its unique structure. It can also be less volatile too for those who are looking for less risk in the portfolio. Today, we’re going to take a closer look at how liquidity and volatility work in the space, and what those terms mean to the way that you buy and sell currencies.
Some pairs are more volatile and liquid, while others can be more liquid and less volatile, or vice versa. Given how often these traits are mentioned in the literature, they are an important consideration when trading. So how do they affect your trading directly? Well, the telepath is here once again to give answers to the questions bothering you and clear off the ambiguity.
What is Liquidity?
Liquidity is often used to refer to the activity of a market. It determines how frequently traders are buying and selling, as well as the total volume of currencies that these individuals may be trading. The foreign exchange market is highly liquid because you can use it to trade on a 24-hour basis during each day of the week. Let’s break it down further.
Liquidity refers to how much money is in the market and the interest to trade right now. You might have heard that Forex is the most liquid market out there (since it’s composed of, well, money.) And this is true! But not all of that money is available for trading at the same time. A currency pair with high liquidity is one where there are lots of traders interested in trading large volumes.
Naturally, more popular currency pairs such as the EURUSD which is also called the Fiber will have a lot more liquidity than exotic pairs that are niche or special, such as AUDNZD. But the liquidity of pairs also depends on what time of the day, or in what season we are in.
For example, if there is a holiday in Japan, then a lot of Japanese traders won’t be trading. So there will be less liquidity in the USDJPY. There is more liquidity when there are more traders, so while Europe and the US markets are open, there is more liquidity in all pairs than when just Australia is open.
What is Volatility?
Volatility is the measure at which the market makes upward and downward movements. Not just how many times it changes direction, but how far those changes go. A currency with more ups and downs is considered more volatile. And a currency with wider swings is also more volatile.
Because currency traders are interested in gaining pips by market moves, volatility is the life mechanism of the Forex trader. But volatility also implies more risk, so it’s about finding the right balance. Volatility can be increased with economic data, as well as more people coming to the market.
Let’s break it into simpler terms, volatility is simply the tendency to change quickly and unpredictably. It could also be a measure of how drastically a market’s prices changes and the price fluctuations in assets. It measures the difference between the opening and closing prices over a certain period of time. Therefore no volatility means there are no price movements right.
Why do you have to understand Forex volatility?
Having a good understanding of Forex volatility can help you decide which currencies to trade and how. It helps you to make the right decisions every time. Volatility is one of the most important concepts in trading in financial markets. It’s a trading term that needs to be well understood.
As earlier said the levels of volatility vary depending on the different currency pairs. Also, more traders trading at the same time usually results in the price making lot of movements up and down, here and there. Therefore more volatility means more trading risk, but also more opportunity for traders as the price movements are larger. So let us just say volatility is directly proportional to the trading risk.
A popular saying goes thus;
To live is to risk dying. Living itself is a risk.
How exactly does volatility affect forex trading?
Without price movement, it will be impossible to have any trading activity. One important point to keep in mind is that a certain level of volatility is needed for markets to operate efficiently. Liquid markets such as forex tend to move in smaller increments because their high liquidity results in lower volatility.
As a forex trader, you need to be aware of the level of volatility of each currency and when volatility is rising. These will help you to make set achievable plans and most importantly help you take the calculated risk so you can protect yourself against heavy losses. Trading volatile currencies always have a higher risk percentage because prices could move abruptly in one direction now and in another in the next few seconds. It is time-independent. Volatile markets are always risky, so one of the things you have to focus on is the art of strategic planning when it comes to trading such markets.
Staying up to date with the latest forex pair news, rates and analysis will be of great help to you in predicting volatility in the market.
While some traders prefer high volatility in markets, others don’t. Another important point you’d need to understand about trading is accurate timing, as currencies might be less liquid during specific sessions.
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