Forex Liquidity: The importance that traders need to know before entering the market

If you have just started trading in the Forex market, the term liquidity (liquidity) might sound mysterious, but in reality, it is a factor that affects your profits and losses every time you press the buy or sell button. This article will clarify those confusions.

What is Liquidity in the Forex Market? A Simple Explanation

Liquidity means the ability to quickly convert assets into cash without causing the price to drop multiple levels. Imagine you want to sell a product. If there are many buyers, the price will drop less (high liquidity). But if no one wants to buy, you have to lower the price significantly (low liquidity).

In the Forex market, where the number of traders for EUR/USD is enormous, prices are stable and easy to access because there are always buyers and sellers. Conversely, exotic currency pairs like USD/TRY have fewer traders, so prices jump up and down, and the spread (the difference between bid and ask prices) widens.

Why is Liquidity Important in Forex Trading?

High liquidity offers three main benefits:

1. Reduce Trading Costs - Narrow spreads mean you save more money each time you open a position. When you trade frequently, these savings accumulate significantly.

2. Reduce Risk of Slippage - When prices move suddenly, your order might execute at a different price than expected (slippage). In markets with high liquidity, this phenomenon occurs less often.

3. Ease of Closing Positions - If you want to exit your trade now in a high liquidity market, you will always find a buyer. No long waiting needed.

5 Signs That Indicate Whether the Forex Market Has High or Low Liquidity

Method 1: Check the Spread (Bid-Ask Spread)

• Narrow spread = high liquidity (Usually EUR/USD around 1-2 pips)
• Wide spread = low liquidity (Some pairs may have 10-50 pips)

Method 2: Check Trading Volume (Volume)

• Highest trading volume for EUR/USD in Forex = excellent liquidity
• Second place: USD/JPY = good liquidity
• Very low volume: GBP/ZAR = poor liquidity

Method 3: Observe Price Movements

• Smooth price movements = deep market, high liquidity
• Jumping prices = shallow market, low liquidity

Method 4: Look at Market Depth

• Multiple order book levels = high liquidity
• Only a few levels = low liquidity

Method 5: Check Trading Hours

• Between 8:00-17:00 GMT (London-New York overlap) = peak liquidity
• Outside these hours, e.g., early Asia, late America = noticeably lower liquidity

Overview of the Most Liquid Currency Pairs

EUR/USD ranks #1 with the largest trading volume in the world. The currencies of the two largest economies give it maximum liquidity. The spread is usually stable at 0.5-2 pips.

USD/JPY ranks second. The Japanese Yen is considered a “safe haven” currency that investors flock to. During market jitters, liquidity remains strong.

GBP/USD is third. The British Pound has a long history, and during London sessions, liquidity surges.

USD/CHF is a “safe” pair. The Swiss Franc consistently maintains liquidity, with increased liquidity during global financial crises.

AUD/USD is important in Asia. Australia exports gold and commodities, so liquidity is good, especially during the Asian-Pacific session.

The Dark Side of Forex: Currency Pairs with Severe Low Liquidity

USD/SEK (Swedish Krona). Although Sweden is a perfect country, the Krona lacks liquidity compared to major pairs, and spreads can explode.

GBP/ZAR (South African Rand). This pair is a market “junk,” with liquidity flowing unevenly. During certain periods, spreads widen.

USD/TRY (Turkish Lira). The Lira is volatile. Economic instability often reduces liquidity, with wide spreads and persistent slippage.

EUR/HUF (Hungarian Forint). A small pair with relaxed liquidity in the market, often with ongoing complaints.

Liquidity Changes Throughout the Day You Should Know

Forex market liquidity is not constant over 24 hours. For example:

• 8:00-12:00 GMT (London opens) = increased momentum and liquidity
• 13:00-17:00 GMT (London-New York overlap) = excellent liquidity, the “golden hour” for traders
• 17:00-22:00 GMT (New York session) = still strong liquidity
• 22:00-08:00 GMT (Asia-Pacific) = reduced liquidity (except AUD/USD remains good)

Major economic news, such as central bank announcements, employment reports, and inflation data, also attract traders, temporarily increasing liquidity.

How Do Volatility and Liquidity Differ?

Volatility = how fast prices change (price swings)

• Major currency pairs tend to have low volatility
• Exotic pairs tend to have high volatility

Liquidity = how much the price drops when selling (who is buying)

• Major pairs have high liquidity
• Exotic pairs have low liquidity

Relationship: Low liquidity markets often experience high volatility because small buy/sell groups can shake prices easily. Conversely, high liquidity markets tend to be more stable.

Who Provides Liquidity in the Forex Market?

Liquidity is not naturally created but supplied by humans and institutions:

• Central Banks - conduct large-scale interventions to provide liquidity
• Major Commercial Banks - front-line liquidity providers
• Hedge Funds (Hedge Funds) - trade in large volumes
• Forex Brokers - supply liquidity to retail traders
• Retail Traders - contribute to liquidity, but collectively, they are small

These liquidity providers, when strong, stabilize prices and make the market more secure.

Factors Influencing Forex Liquidity

( Factor 1: Time The Forex market never sleeps, but only during certain times. The overlap between London and New York is the hottest period.

) Factor 2: News Employment figures, GDP data, interest rate announcements, and economic news of a country increase liquidity as traders become active.

Factor 3: Market Sentiment

Market mood affects liquidity. Calm markets with low volatility/uncertainty reduce liquidity. Good market sentiment encourages traders, increasing liquidity, provided they are not fearful.

Small Tips for Beginners

If you are trading Forex for the first time, manage your risk by:

1. Choose high-liquidity pairs - such as EUR/USD, USD/JPY to avoid wide spreads and slippage
2. Trade during peak hours - try to enter the market when liquidity is at its best, during London-New York overlap
3. Check the economic calendar - before major news releases, liquidity may decrease. If you are a beginner, avoid trading then
4. Learn about Market Depth - observe how many buy/sell levels there are. More levels indicate better liquidity

Summary

Liquidity is the market’s breath. Understanding it correctly helps you save costs, reduce risks, and trade happily. The interaction between liquidity and volatility means that the pairs you choose should always match your experience and capital.

Once you understand that liquidity means the ease of converting assets into cash, you will realize why major pairs are more popular among traders than new pairs 🚀.