Forex Market Liquidity: What Is It And Why Is It Important For The Forex Market

Trading in foreign exchange dates back to ancient times. Today, with 180 distinct currencies, the FX market is the most liquid globally, driven by transactions and trades. Staying updated on market trends provides valuable insights into factors affecting volatility and liquidity and enables profitable transactions.

Explaining Forex Liquidity

Foreign exchange liquidity is a key factor in market dynamics, affecting both financial and tangible assets. It refers to the speed and ease with which an asset can be bought, sold, or converted into cash at stable prices. Liquidity in trading is the balance between supply and demand, affecting the ease of finding buyers or sellers, while market illiquidity hinders transactions due to a lack of participants.

Retail traders should consider spreads and currency pair volatility as indicators of market liquidity. An illiquid market has unpredictable price movements due to wide fluctuations in buying and selling volume, while a very liquid market, also known as a deep or smooth market, requires minimal price fluctuations. The number of traded currency pairings affects FX liquidity, with USD being the dominant currency. The foreign exchange market is open 24/7, with American and European markets experiencing the most action.

Market liquidity is a complex concept, but indicators like share turnover, trading volume, bid/ask spread, and firm performance can help estimate market depth. High volume in stock markets indicates greater liquidity, while narrower spreads indicate lower transaction fees in liquid markets.

Liquid And Illiquid Brokerages

Here are some indicators that can help you identify the level of brokerage liquidity:

• Indicators

Brokers often offer a “volume” option on charts to assess liquidity in FX pairs. These indicators are analysed by examining trading activity bars. However, brokers only display their liquidity data, not the overall FX market liquidity. Using their liquidity as a reference can accurately represent the retail market.

• Gaps

Forex gaps occur when significant news, like interest rate announcements, affects the market. Equity markets trade 24 hours daily, allowing traders to enter and exit freely. Markets that only trade for a portion of the day are more volatile due to overnight news.

• Timing

Forex liquidity fluctuates during trading days, with major support and resistance levels often occurring during less busy hours. Breakouts and larger percentile changes are more likely during London and US sessions. 

What Do Liquidity Providers Do?

Broker liquidity providers create pools for various financial institutions to provide quotes and data to minor participants, thus improving market efficiency by reducing spreads and eliminating price gaps. These providers come in Tier 1 and Tier 2, with Prime-of-Prime liquidity pools being the most substantial in the FX market.

To connect with an LP in the Forex market, a brokerage firm must research and select a reputable provider, complete an application form, discuss partnership details, choose the most suitable aggregation and liquidity venues, and choose the most suitable liquidity venues like PrimeXM or OneZero.