Good day forex traders.
Welcome to another learn forex trading article.
Have you heard about how potentially dangerous it is to trade during low volume or low liquidity conditions? Yes it can be at times due to the unpredictable movement of the currency pair. Such movements can even be fast at times, resulting in spikes and dips.
Do you know why that happens? Allow me to share with you in easy to understand terms.
In any financial market such as equities or currency exchange which is forex, the basic activity is buying and selling. When a price is matched, a transaction occurs.
Example : 100 traders want to sell EUR/USD at the market price.
1) Normal Volume / Normal Liquidity
On a normal market day, due to the massive size of the currency exchange market, there are many traders wanting to buy the EUR/USD at market or near market prices.
Market price : 1.3200
50 traders willing to buy
Next best price : 1.3199
25 traders willing to buy
Next best price : 1.3198
25 traders willing to buy
At the end of this transaction, the market price would have fallen from 1.3200 to 1.3198.
2) Low Volume / Low Liquidity
On a low volume day, for example during a festive season, the number of traders wanting to buy the EUR/USD will be fewer.
Market price : 1.3200
10 traders willing to buy
Next best price : 1.3198
20 traders willing to buy
Next best price : 1.3193
30 traders willing to buy
Next best price : 1.3190
20 traders willing to buy
Next best price : 1.3185
10 traders willing to buy
Next best price : 1.3180
10 traders willing to buy
At the end of this transaction, the market price would have fallen from 1.3200 to 1.3180. This is because lower prices must be sought after so as to completely match the 100 traders’ sell orders.
Therefore when the forex market is having a low volume or low liquidity, such unexpected spikes or dips may happen when the market price needs to be stretched further to meet a particular demand.
Trade Safely.
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