Volatility and Liquidity
Up until now we’ve referenced the terms volatility and liquidity, and we’ve yet to fully explore definitions and meanings for these conditions as they relate to the forex marketplace. Generally, the more volatile a market, the better for short-term speculators looking to make a quick return. The less volatile a market, the better a long-term investment it may make, in the sense that it will prove less risky. If a market is more liquid than another, it enables transactions to be completed with greater ease and leads to more honest pricing. But what do these terms mean each individually, and what does this mean for you as a forex trader?
Volatility is a measure of how far a market moves in any given price cycle. In the same way volatility in human personality would indicate the potential to easily anger or swiftly sadden, so too in market terminology does it represent those markets that have a wider cycle between highs and lows. Volatile markets are opposed on the pole by stable markets, which tend by definition to have shorter cycles, with less of a gap between high and low market prices.
More volatile markets pose better opportunities for leveraged traders to make a profit in as short a period of time as possible. The bigger the swing in prices, and the greater the likelihood for markets to move, the greater the chances for the trader to wring out profit from their trade.
With forex, the currency markets tend to veer towards the less volatile end of the market, because those that drive the prices tend to be governments and massive global banks. For this reason, serious degrees of leverage tend to be involved in most forex transactions, as a compensatory measure to ensure traders can still maximise their returns.
In the same breath, liquidity is another key issue affecting traders across all different types of markets. Liquidity is measured as the proximity of an asset or market to cash. So for example, a car is an illiquid asset, because it is at least several degree of separation from cash (finding a buyer, concluding a sale and exchanging the asset for cash value all take time and pose additional risks to the asset holder). With forex, foreign currency literally is cash, and therefore its no surprise that the forex markets are the most liquid markets there are. Added to which, there are real incentives for international monetary supplies to be monitored in relation to geopolitical and economic goings on, and the impact of many disparate traders with disparate needs ensures that reasonable, realistic market prices can be achieved.
Liquidity and volatility are important terms to get your head around before you throw yourself any more directly into the forex markets, and they play a critical role in helping inform your trading decisions. But as a low volatility, high liquidity marketplace, what are the benefits of forex trading for regular retail traders like you?