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The Relevance of Liquidity in Foreign Currency Exchange

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Foreign currency exchange depends upon liquidity to keep it going. For the most part, all the major banks of the world do a pretty decent job of “greasing the skids”. For example, in the latest Bank of England report on this subject, banks in London were processing orders in excess of USD 2.55 trillion/day. It’s estimated that London handles 1 out of every 3 trades in forex. This means that forex is, by far, the largest capital market in the world. As a trader, this also means that you don’t have too many liquidity worries, except for during 2 “twilight zones”. The first occurs before Auckland opens up. Stop loss vampires cruise the screens looking for newbie meat to devour. The second occurs as Asian winds down its trading day, but London hasn’t hit the scene. Swiss gnomes have been known to get up early, sliding into EUR/JPY trades when no one is looking.

If a market is liquidity, go with “market pricing”. If it’s not, use “limit orders” instead.

Liquidity Defined In Foreign Currency Exchange

In finance, liquidity is the term for “cash on hand”. So, if someone says “there’s a lot of liquidity”, this means that there’s a lot of cash sloshing around. On the other hand, if you hear the phrase, “liquidity is thin”, it means that – for some reason (and, it could just be an upcoming national holiday) – there’s not a lot of cash available at the moment. In forex, the central banks and larger commercial banks provide the liquidity needed. How much? A lot. For instance, according to the US Federal Reserve, the total amount of forex spinning through all US banks in April 2013 was in excess of USD 1 trillion/day (for the UK, the number was USD 2.55 trillion/day).

The Importance Of Liquidity In Foreign Currency Exchange

When you have a lot of money available for a deal, the buy price (aka, the “bid”) and the selling price (aka, the “ask”) tend to be close together. As a trader, you want a “good fill” (i. e., a nice trade execution price). If liquidity is getting thinner, you’ll notice that the bid/ask spread has widen and, all of a sudden, you’re not getting such wonderful fills. The best liquidity conditions are usually when both Europe and the North American East Coast are open for business. After Europe closes down, North America usually remains pretty liquid until about lunch time in San Francisco (i. e., 3:00 pm in New York City). Try to trade only in highly liquid conditions.

Making Money From Foreign Currency Exchange Market Liquidity

The nice thing about trading in liquid markets is that you can enter a trade at a “market price” (i. e., whatever is available) and, usually, not have to worry that you got skinned in the process. In illiquid markets, you have to worry. So, what happens is that you request a “limit price”, based on a “limit” (like a very specific number). This takes care of being potentially ripped off, but it doesn’t guarantee that your number will get hit. So, when you put in a “limit order”, you are “pending a fill” (that may never happen). However, this is better than being “filled” at a price that swallows up your potential profit – a big worry for day traders.

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