Liquidity and volatility - one of the basic correlations of the Forex market

For a trader who is just starting his adventure with financial markets, concepts such as liquidity and volatility may be incomprehensible. In order to make money consistently and repeatedly on the market, you must not only understand the issues presented, but more importantly you must learn to use them in everyday trading. If investing is proverbial yours "daily bread", you certainly know both concepts. However, if you are a beginner trader who is just starting his first steps, it's important that you understand what role both factors play in market analysis. In this article we will discuss both concepts and the relationships that occur between them.

Understand liquidity

In simple terms, the term liquidity refers to how fast and how easy you can be on market to buy or sell something. It is a way to measure the depth of a given market. The essence and key to understanding this issue is contained in a simple example. Let's assume that we are interested in the market of the popular currency pair cable, i.e. GBP / USD. We want to open a long position at 1.25 level. This type of transaction involves the simultaneous purchase of a pound and the sale of the dollar. Of course, we as traders never see it because it is contained in a single order. Now another question arises, namely: How quickly is one of the market operators, i.e. let's assume our broker, able to complete this specific order? The undoubted advantage of the currency market is the fact that it is one of the most liquid markets and orders are carried out almost immediately. In practice, this results in the fact that we can both buy and sell certain assets without really worrying about liquidity, at least up to a certain level of order size (in the case of 99% of retailers this will not be a problem).

Determination of variability

Sometimes you may wonder how quickly the price of a particular instrument changes? The answer to this question is just volatility. This is nothing else time in which the market price changes in a given unit of time. When it comes to the biggest fluctuations, they undoubtedly take place on the currency market during the publication of important macroeconomic data, such as the popular NFP, i.e. a change in employment in the non-agricultural sector. It is very important to realize that fluidity and variability are interrelated and one relationship can affect the other. If someone trades for a slightly longer period of time, you have certainly observed certain periods in which volatility drops. We can also call it illiquid, either  the so-called. "Narrow" market. The lack of buy and sell orders means that the market is more susceptible to fluctuations than usual. It takes a smaller volume to move the price and push the market either way up or down.

Correlation of liquidity and volatility and technical analysis

How to use these concepts in practice? The more liquid the market is, the more reliably its technical aspects can be. Every transaction that takes place on it is someone's opinion. What "controls" specific assets are the beliefs that build among investors. Everyone really takes one side and decides whether he thinks the price will go up or down. The stronger the belief, the more reliable and trustworthy the result can be.  If we translate it into real trade, the conclusions can come to themselves. During the holiday and holiday periods, the decrease in liquidity usually causes technical signals to lose their effectiveness. Markets are also becoming more susceptible to so-called fakes. The same can be said about Friday sessions. The volume is usually smaller, which often translates into smaller ranges in which the price moves. Friday breakouts should always be analyzed with greater care and well planned if we want to enter the market right at the opening.

Another thing to look out for is that variability can affect the reliability of an analysis. The bigger it is, the more it can be noise. If in your trading you use, for example, the maximum and minimum candle, which was created on a very high volatility, be careful. It is also likely that the prices of individual brokers will vary slightly during rapid changes.

Be sure to read: False Breakouts - Control of the play in the Forex market

Podsumowując:

• Liquidity refers to the depth of buy and sell orders. A liquid market is one where we quickly buy or sell.
• Volatility refers to the pace of market changes. A variable market is one in which the rate of price fluctuation in a given period of time is high relative to other, similar markets or periods.
• a "narrow" market with low volatility can also be liquid. Fewer orders mean that it is easier for buyers and sellers to influence price direction.