Quiet summer for FX market
Quiet summer for FX market
The foreign exchange market is a global marketplace where the activities of buying, selling, and speculation of currencies takes place. With daily trade volume reaching well into the trillions, it is safe to say that it has become the most liquid financial market today. That said, even veteran traders fail to see how variations in the amount of liquidity within the trading place can significantly affect the value of the currency being exchanged. Before we explain the connection, it is first important to understand what liquidity is.
Liquidity is simply comprised of the number of active currency traders and the amount of money being traded that is present in a given market at any given time. That said, individual trader’s will need to pay more attention to the volatility of the price movements that is a result of the market liquidity levels. For example, if the market is more liquid at present time, one can expect to see less price movement and in smaller amounts. In the opposite case, the less liquid market will have room for more volatility and therefore see prices fluctuate quicker and in larger amounts.
What causes liquidity levels to vary so abruptly in the marketplace? One reason is the opening and closing of the different global financial centre’s based on their location and time zones. For instance, lower levels of liquidity are seen during the Asian trading session, as it is the first to open for the day. Peak liquidity will be seen when the European markets open, as it begins operation in the morning while the Asian markets are still trading. The American market then adds to the liquidity levels as opens up later on during the afternoon. It then makes sense that upon the closing of European markets, liquidity will drop down sharply.
The cause of lower levels of market liquidity is not just limited to the opening and closing of the different marketplaces. Market holidays also reduce the liquidity levels in the marketplace due to less participation. The risks also increase when sudden breakouts and market trend reversals occur. During these periods where liquidity is further reduced, aggressive market speculators such as hedge funds will exploit the market and push it past key technical points. As such, these market breakouts or reversals are pushed even further to the point where an investor is now facing major losses to their initial trading strategy.
It is during the phases of decreased market liquidity that currency rates are prone to abrupt and larger price movements. While the cause can be anything, from actual market events or rumour and speculation, the result is still the same. More abrupt price changes than what it would be during more liquid levels. It is also important here to mention that the direction and gravity of the price movements during these illiquid periods cannot be predicted, and whether willingly or not, you are choosing to expose yourself to more risk. Therefore, investors need to be aware of and actively try to recognize the different fluctuations in liquidity conditions and accordingly factor these into their trading strategies.