How liquidity affects forex trade

Liquidity, in simple terms, is the ease with which two currency pairs can be traded in forex trade. The more stable and popular currencies are more liquid vis-a-vis an exotic pair of currencies. So, with combinations like the dollar (USA) and the pound (Great Britain) or the dollar (USA) and the yen (Japan), traders will be able to enter and exit the market easily.

The liquidity in the forex market determines how well you can execute your trade, how much slippage, as well as volatility is present. So, here is all that you must know about liquidity in the forex market before you execute a trade.

NOTE: Forex investments involve significant risk. Do not take the views mentioned here as financial advice. Please conduct thorough research before making any investment.

Contributors to the forex market liquidity

Before one understands how liquidity affects the forex market, they must understand who contributes to this liquidity and how:

• Banks
• Retail traders
• Market makers
• Asset managers

Liquidity and its impact on forex trade

The cost of the transaction in forex trade

The cost of a transaction in trading depends on the spread, which in turn is determined by the demand and supply for a currency pair. The higher the demand and supply, the smaller the spread and the lower the cost of transaction. In simple words, a smaller spread means you start your trade closer to breakeven.

The slippage

The slippage for a trader is the difference between the price at which they expect to trade versus the price at which the trade actually happens. When the liquidity is high, there are plenty of matching orders. Hence, the trader gets to trade at a better position with high liquidity and vice versa with low liquidity conditions.

Broker costs

The brokers connect buyers with sellers in a trade. Now, when the liquidity is high, the brokers can easily match orders, and hence the broker charges are low.

More stable charts

Most traders rely on forex trade charts and chart-based metrics to make trade decisions. At higher levels of liquidity, the markets are more stable, and so the trade charts better reflect market conditions.

The type of trading carried out

Liquidity in the forex trade determines the type of trading that can be carried out. High-frequency forex trade is only possible with deep liquidity in the market.

Higher aggregate savings in the long term

When the liquidity is high, the savings per trade can be aggregated in the long term to earn solid profits in forex trade. For instance, if a trader saves one pip per trade and they carry out 200 trades in a month, the cumulative savings become huge.

Edited by Abu Amjad Khan