There are correlation between currency pair, liquidity, and volatility in the forex market that will benefit you when you have knowledge about it. This article will talk about this topic and provide you with an alternative in choosing which currency pair to concentrate in.

There are correlations between currency pair, liquidity, and volatility in the forex market that will benefit you when you have knowledge about it. This article will talk about this topic and provide you with an alternative in choosing which currency pair to concentrate on.

 

What Is Liquidity?

Forex liquidity refers to the degree of ease with which a currency pair can be bought or sold in the foreign exchange market without significantly impacting its price. It is a measure of the depth and efficiency of the forex market, indicating the ability to execute trades quickly and at desired prices.

In the forex market, liquidity is primarily influenced by the trading volume of a currency pair. Currency pairs with high liquidity have a large number of buyers and sellers actively participating in the market. Major currency pairs, such as EUR/USD, GBP/USD, USD/JPY, have high liquidity as they involve currencies from highly liquid economies and attract significant trading activity.

The presence of liquidity providers, such as banks, financial institutions, and market makers, also contributes to forex liquidity. These entities continuously quote bid and ask prices, providing liquidity by being willing to buy or sell currencies at those prices. Liquidity providers play a crucial role in ensuring that there are always counterparties available for trades, even during times of high market volatility.

Having high forex liquidity offers several advantages to traders, including:

  • Tight spreads: High liquidity typically leads to narrow bid-ask spreads, which is the difference between the buying and selling prices. Tight spreads reduce transaction costs for traders.

  • Efficient execution: With high liquidity, traders can quickly execute their orders without experiencing significant slippage, which is the difference between the expected price and the actual executed price.

  • Price stability: Forex pairs with high liquidity tend to exhibit price stability, as there are many participants actively trading and contributing to price discovery. This stability reduces the risk of sudden price gaps or significant price movements.

  • Flexibility: High liquidity allows traders to enter and exit positions of various sizes without impacting the market. It provides the ability to open or close positions quickly, enhancing trading flexibility.

On the other hand, forex pairs with low liquidity may have wider spreads, limited trading activity, and higher slippage, making it more challenging to execute trades at desired prices, particularly for larger positions.

Forex has the greatest liquidity in the financial markets. However, not all currency pairs have the same liquidity. If a currency pair is liquid, this will attract more speculators, thus adding more liquidity. If there are more speculators and more liquidity, there will be more trades executed with the currency pair.

Depending on the global economy, these actions could create more volatility. Volatility and liquidity can entice traders to enter the market. Consequently, there will be a lot more market participants or traders for currency pairs with higher liquidity and volatility. For example, the EUR/USD pair is considered more volatile and liquid compared to GBP/CAD pair, and therefore traders trade this pair more regularly.

This doesn't mean that there can't be big moves in some of the less liquid currencies. Of course, there can be. As long as there are transactions and underlying fundamental reasons, less liquid currency pair can easily move hundreds or even thousands of pips. For instance, EUR/NZD has made large moves over the past year.

This table shows the liquidity of some important currency pairs:

currency

 

What Is Forex Volatility?

In the foreign exchange market, volatility refers to the degree of fluctuation in the prices of currencies. It is measured by the standard deviation of price changes over a period of time. Volatility can be high or low, and it can change over time.

There are a number of factors that can affect forex volatility, including:

  • Economic news: Economic news, such as interest rate announcements or GDP reports, can cause volatility in the forex market. This is because economic news can have a significant impact on the value of currencies.

  • Political events: Political events, such as elections or natural disasters, can also cause volatility in the forex market. This is because political events can have a significant impact on the stability of economies and currencies.

  • Speculation: Speculation is another factor that can affect forex volatility. Speculation is when traders buy or sell currencies in the hope of making a profit from short-term price movements. Speculation can increase volatility in the forex market, as it can lead to large swings in prices.

Volatility can be a good thing for traders, as it can provide opportunities to make profits. However, it can also be a risky thing, as it can lead to losses. Traders should carefully consider the level of volatility before entering a trade.

Volatility is measured in terms of how many pips a certain pair moves in a day. Just like how each pair differs in liquidity, some currency pairs are more volatile than others. Some pairs can easily move 100 pips in a day, while other pairs only move less than 50 pips.

The more a currency pair moves in a day, the greater the chance for forex traders to make profits within that day. Some currency pairs that tend to move more than 100 pips a day are GBP/USD, USD/CHF, and EUR/JPY. Day traders love these pairs because they offer good opportunities to capture big-sized profits in a short period of time.

currency

Note: This is not the conventional way of measuring volatility. This table shows volatility in terms of what is most easily measured by traders.

With the information above, knowledge about both liquidity and volatility of currency pair can give you an idea of which pair is the best to trade. So you can concentrate on some particular pairs to make more profits.