Liquidity in Forex

Liquidity in forex

Liquidity means the ability of a market to buy and sell financial assets at a reasonable price and low cost. The liquidity of a market is determined by various factors such as the number of buyers and sellers, the volume of transactions, the speed of execution of orders, and the difference between the offer and demand prices. The liquidity of the forex market, which is the largest and most voluminous financial market in the world, is very high. The liquidity of the forex market is very important for investors and traders, and it makes orders to be executed quickly and at an accurate price, the cost of transactions is reduced, the market risk is reduced, and the ability to analyze the market is improved. Also, the liquidity of the forex market provides access to the side markets. This article examines the importance, types, factors and methods of measuring liquidity in the forex market.

Liquidity in the forex market

The forex market is a high-volume and highly liquid market, according to the World Bank, the daily volume of the forex market in April 2022 was more than 7.5 trillion dollars. This amount has increased compared to 2019, when the daily volume of the forex market was 6.6 trillion dollars.

The high volume of transactions has caused the forex market to be welcomed by traders as a liquid market. Liquidity means the ability to buy and sell currency pairs based on market demand. Liquidity makes the prices stable and competitive and the cost of transactions is reduced. The more the amount and volume of liquidity in the market, the more rational the prices are compared to the technical. Liquidity in the forex market is affected by various factors such as timing, volume, liquidity providers and market changes.

Time means the working hours and days of different financial markets, which have an effect on the liquidity of the forex market.

Volume refers to the number and size of trades that take place in a specific time period.

Liquidity providers are individuals or organizations that place their assets in the majority of currency pairs available to the market.

Market changes are economic, political and social events that affect the supply and demand of currency pairs.

Forex market liquidity means how quickly a currency can be bought or sold without affecting its price. Forex market liquidity is created by trading activity. When the supply and demand for a currency is high, the liquidity of the forex market will also be high. Measuring liquidity in the forex market is a complex process that requires the use of various methods.

The liquidity of the forex market can be measured using several indicators. These indicators are: spread, volume, depth, reserve and index.

  • Spread: the difference between the prices that buyers and sellers are willing to accept. In high liquidity markets, the difference between supply and demand will be less and vice versa. In simpler language, the difference between the buying and selling price of a pair is called “spread”. This is why the lowest amount of spread is seen in the euro-dollar currency pair, due to the high volume of transactions in this currency pair.
  • “Trading volume”: refers to the total number of a specific currency traded in a period of time. High trading volume means higher liquidity and better execution cost.
  • “Deep” number of buy and sell orders at different price levels. Market depth shows how much a large trade can change the price.
  • Reserve refers to the amount of liquid assets that are available by liquidity providers such as a financial institution or central bank to meet its monetary needs. This reserve is usually in the form of foreign currency or gold and can be used to stabilize the exchange rate, provide loans or regulate cash flow.
  • An index is a number that is obtained from market data based on statistical methods.

There are various solutions to improve the liquidity of the forex market. Some of these solutions are:

– Increasing market transparency: information about prices, volumes, orders and the identity of market operators should be made available to the public in a clear and transparent manner. This will increase confidence and also increase market mobility.

– Promotion of fair competition: Appropriate laws and regulations should be established to prevent behavior against the public interest, such as attempts to change prices, conflict of interest, collusion and misuse of confidential information. This will maintain the health and efficiency of the market.

– Facilitating access to the market: reduce the barriers and costs of entering and exiting the market. This will attract new investors and expand the market.

Why is liquidity important?

If a market is not liquid, it will be difficult to sell or convert assets into money.

For example, suppose you have an expensive product and you intend to sell it, but you do not have a buyer for your product, or if there is, the number of people who request to buy is small, and if you intend to sell, you have to sell your product with Sell ​​it at a lower price and if there is no market or buyer for it, no one will be willing to pay you the real price.

You may even have to hold an auction to sell it and ask intermediary companies to find a customer for you, which will be time-consuming and expensive. In this situation, we say that the liquidity of this device is very low.

But assets that have high liquidity can be bought and sold easily and in the shortest time at their real price and do not incur any side costs. For example, the gold coin in Iran is highly liquid and you can easily sell it at the daily price whenever you want.

In addition, companies are also required to have enough liquid assets to be able to use them to pay their debts and expenses. Otherwise, they may face bankruptcy.

Here are a few markets:

Liquidity in Tehran Stock Exchange ” market :

Tehran stock market only has the ability to buy and does not have the ability to sell on borrowing. This factor makes the market not ideal. There is a possibility that the trading symbol will be closed for a period of time to hold a general meeting or important stock news and the investor will not be able to cash out his capital from the stock market during this time. For example: the change in the rules of the central bank caused the closure of banking symbols for 5 months and a drop of about 50% in banking stocks.

Liquidity in the cryptocurrency market digital currencies :

In the digital currency market, liquidity is also “the ease of converting a cryptocurrency into cash”. Currently, “Bitcoin”, which is the first and most popular cryptocurrency in the world, is considered the most liquid digital currency.

Since the number of cryptocurrencies registered on statistical sites in December 2021 was close to 9 thousand and reached more than 20 thousand in 2023, it is especially important to pay attention to the liquidity of each cryptocurrency before buying. You may have bought a large amount of a cryptocurrency with low liquidity, but because not many exchanges support it yet, you will most likely have difficulty selling it for its true value, and some coins may even be removed.

Liquidity in the Forex ” market :

With the explanations given above about liquidity, we come to the conclusion that by comparing the markets, the forex market is the best market for traders and there is a possibility of liquidity at any moment.

Among the different currency pairs in the forex market, we must point out that the currency pairs that have a lower spread such as “Euro to Dollar” have a higher volume of liquidity and are more popular among traders in the forex market.

As a result: traders choose a market with higher liquidity for their business.

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