Home Money & Finance Using liquidity and volatility to your advantage when Forex trading

Using liquidity and volatility to your advantage when Forex trading

by Olufisayo
Forex trading

If you’ve been paying attention to the financial news over the last couple of months, you will be aware that the global economy has been suffering some serious ups and downs.

Much of that is due to the developing impact of the COVID-19 pandemic, which has thrown the financial markets into complete chaos, with governments adopting a range of robust measures in response to try and calm the unfolding economic storm. This has been true for the markets of all asset classes, from crypto and forex to commodities and currencies.

But the news from the markets hasn’t all been doom and gloom. In fact, despite the massive downturn in the global economy, we have also seen several news stories emerge in which the financial markets have posted record-breaking daily increases.

What is behind these seemingly contrasting market trends? How can the global economy be heading for recession, while also posting record-breaking daily increases?

The market force at play here is volatility. And although you might have seen this term regularly mentioned in numerous trading guides and forex broker reviews, you might have wondered what it means in detail.

       

When we see a particular market—whether it is the market for a particular currency, stock, or commodity—having massive swings upwards and downwards, this is an indication that the market is very volatile. At its most basic definition, volatility is the measure of how much an asset’s price swings and fluctuates around the mean price for that asset.

Traditionally, volatility is often considered a negative market force because when a market for a given asset is volatile, it is regarded as being a more risky investment or trading opportunity. However, given that market volatility involves big swings up and down, if you are experienced and know how to read market forces, you can use volatility to your advantage.

Particularly when forex trading, individual currency pairs can be subject to significant amounts of volatility for a prolonged period, while the average price might remain relatively static over time. Noticing this allows you to buy when volatility forces the market prices down and to sell high when it swings up.

Another common term we also see used in conjunction with market volatility is the overall liquidity of the particular market in question. Liquidity refers to how easy it is to buy or sell a specific asset. In the context of forex trading, this would be the ability to buy and sell a particular currency pair, such as the EUR/USD.

Market analysts often look to liquidity as a way of assessing the overall health of the market or the individual market for a particular currency pair. A market is considered to be highly liquid if there is a lot of trading activity, and currency can be bought and sold with relative ease.

       

Liquidity is incredibly important to bear in mind when formulating and executing a forex trading strategy because it will determine how quickly you can open and close trading positions. Markets become more liquid if the trading conditions are favorable, with liquidity also being impacted by external events.

We can thus see how volatility and liquidity are two of the most basic yet powerful forces affecting the forex markets, both of which should be incorporated into any forex trading strategy.

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