The forex market is one of the largest entities of its type in the world, with an estimated $5.1 trillion traded each and every day across the globe through this platform.
This is also one of the most volatile financial markets, whilst the foreign exchange offers considerable liquidity for investors of all descriptions. However, novice traders can struggle to understand the impact of volatility and liquidity in the marketplace, despite the wealth of information available through trading platforms such as Oanda.
In this post, we’ll consider the concepts of liquidity and volatility in further detail, whilst asking how they impact on your potential profitability.
What are the Definitions of Liquidity and Volatility
Liquidity refers to active a market is, and more specifically the degree to which an asset or security can be quickly bought or sold at a price that reflects its intrinsic value.
On a fundamental level, cash is universally considered to be the most liquid asset, whist tangible securities such as fine art and real estate sit at the opposite end of the spectrum.
In the forex market, liquidity is determined by how many investors are actively trading and the cumulative volume that they’re dealing in, as this has a direct impact on demand and price movements. Currency also underpins a deep marketplace that’s accessible 24-hours each day, and this also lends itself to higher levels of liquidity.
In the case of volatility, this is the measure of how dramatically a market’s prices shift within a predetermined period of time. The volatility of the forex market is also influenced by the prevailing level of liquidity, with minimal liquidity resulting in more violent price fluctuations on average.
Conversely, higher levels of liquidity typically translate into a less volatile marketplace, where prices change slowly and in a more predictable manner.
Forex traders will also note that highly volatile markets can be extremely profitable, as they speculate on rising or declining prices as they’re not required to assume ownership of the underlying financial asset.
Which Currency Pairings Offer the Best Value to Traders?
In general terms, investors are known to prefer high levels of market liquidity, primarily because this underpins more predictable price trends and reduced volatility.
This is embodied by several different currency pairings, with the USD/JPY offering the best case in point. This is commonly referred to as “the ninja” and is the world’s second most traded currency pair, and its high trading volumes lead to low bid-ask spreads and high volumes of liquidity.
The so-called greenback features heavily in highly liquid pairings, with the GBP/USD the next on our list. This also offers tight bid-ask spreads to traders, whilst its incredibly accessible to investors across the globe.
The same can be said for the EUR/USD, as this boasts a similar demand whilst the single currency is also closely affiliated with the British pounds thanks to the UK’s position within the EU.
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