In depth analysis of the importance of MT4 and MT5 foreign exchange transaction liquidity

Abstract: when a trader starts foreign exchange trading, the first advantage he or she may encounter is that the foreign exchange market provides more liquidity than other markets. According to the three-year report issued by the bank for International Settlements in 2016, the daily trading volume of the foreign exchange market is about US $5.1 trillion.

The liquidity of foreign exchange can facilitate transactions, making the foreign exchange market popular with traders. After all, to ensure liquidity, investors need to consider some variables in the foreign exchange market. This paper will explain the concept of foreign exchange liquidity and liquidity risk, and ultimately seek an overall understanding of how liquidity affects transactions. What is liquidity? Why is it important?

By definition, liquidity in the foreign exchange market refers to the ability of money to trade (buy / sell) on demand. When you are trading major currency pairs, you are trading in a highly liquid market. However, your transaction is based on the available liquidity of financial institutions, which can allow you to enter or exit the transaction (currency pair) of your choice. Not all currency pairs have strong liquidity. In fact, currencies tend to have varying degrees of liquidity, depending on whether they are major, minor, and exotic (including emerging market currencies). From major currency pairs to minor currency pairs, and finally to foreign currency pairs, foreign exchange liquidity decreases in turn.

High liquidity:

High liquidity of foreign exchange refers to currency pairs that can be bought / sold in large quantities without causing significant changes in exchange rate / exchange rate, such as major currency pairs, such as euro / US dollar.

 

Other major (highly liquid) currency pairs that need attention:

GBP / USD

USD / JPY

EUR / GBP

AUD / USD

USD / CAD

USD / CHF

NZD / USD

Low liquidity:

Low liquidity of foreign exchange means that currency pairs cannot be bought / sold on a large scale without causing large fluctuations in the exchange rate level, such as foreign currency pairs, such as Polish zloty / yen.

Foreign exchange liquidity and illiquidity: three signs that need attention

From the perspective of traders, a market with poor liquidity will have chaotic trends or gaps, because the level of buying or selling at any time may be very different. High liquidity market is also known as deep market or stable market, and the price trend is also very stable. Most traders need and should require a highly liquid market, because in a market with poor liquidity, if you choose the wrong side when a big market occurs, it is difficult to manage risks.

Here are three signs to note

1. Gap in foreign exchange trading

Compared with other markets, the gap of foreign exchange is different. However, if there is an interest rate decision or unexpected news with significant influence, there may be a price gap in the foreign exchange market.

There may be a gap when the foreign exchange market opens on Sunday afternoon, us time. If news is announced at the weekend, the overall gap of foreign exchange is usually less than 0.50% of the value of a currency. Markets like the foreign exchange market, which trades 24 hours a day, are considered to be highly liquid markets, or because of continuity, their gap is often smaller than that of the stock market. This allows traders to enter and exit the market at will. However, a market such as the U.S. stock market or futures exchange, which can only be traded for a small part of the day, will be compressed into a smaller market, because if the overnight news is contrary to market expectations, the price may jump at the opening.

2. Foreign exchange liquidity indicators

Brokers often provide the option of "volume" on the chart, according to which traders can measure the liquidity of the market. This indicator of foreign exchange liquidity is explained by analyzing the histogram on the trading volume chart.

Each trading volume bar represents the trading volume in a specific period of time, so as to provide traders with an appropriate approximate indicator of liquidity. It should be remembered that most brokers only reflect their own trading volume data, not the liquidity of the entire foreign exchange market. However, using the trading volume of brokers as a measure can appropriately represent the liquidity of the retail market according to the size of brokers.

3. Liquidity is different in different time periods of the day

Short term traders or scalpers should pay attention to the changes in foreign exchange liquidity during the trading day. In some less active periods, such as the Asian period, the market is usually sideways, which means that from the perspective of speculation, the support and resistance levels are more likely to remain. In highly volatile market periods, such as London and the United States, the market is more likely to break out or have large percentage fluctuations.

In a day, you are likely to see the most volatile period is the morning trading in the United States, because it overlaps with the European / London period, which alone accounts for more than 50% of the world's total daily trading volume. In the United States alone, it accounts for about 20%. In the afternoon of the United States, you will often see prices plummet, unless the Federal Open Market Committee (FOMC) makes a sudden statement, which is only a few times a year.

 

 

 

Liquidity risk vs return

The relationship between risks and returns in financial markets is almost proportional, so we must consider and understand the risks in transactions.

A major example of liquidity risk in the foreign exchange market is the Swiss Franc crisis in 2015. The Swiss central bank announced that it would no longer adhere to the Swiss franc's peg to the euro, leading to a break in the interbank market due to the inability to price. This resulted in brokers being unable to provide liquidity in the Swiss franc. With the recovery of interbank pricing (the backbone of foreign exchange pricing), the price of euro / Swiss franc is far from reaching the previous range. This has greatly affected the retail account balance of those trading Swiss francs. Although these "black swan" events are rare, they are not impossible.

Retail foreign exchange traders need to manage these liquidity risks by reducing leverage or using guaranteed stop losses. Brokers are obliged to execute your stop loss instructions.

The choice between balancing liquidity risk and return should not be ignored and should be part of the daily analysis of traders.