It is a widely known fact that FX market liquidity is crucial for traders since it impacts transaction times, limits slippage, and, eventually, profits. When there isn’t enough money floating around, deals take longer to close, and fewer people are willing to buy and sell.
So why do we need liquidity?
To guarantee that market makers always have accessible funds for clients, forex liquidity brokers function as market makers. As a result, they provide a marketplace where buyers and sellers can engage and negotiate deals. To ensure that traders never experience delays while submitting orders or completing transactions, it is the responsibility of these firms to ensure that there is always adequate liquidity.
What happens if there is no liquidity?
Trading in the Forex market would literally cease if liquidity were unavailable. Without any form of liquidity, the Foreign Exchange market would grind to a standstill, and traders would be unable to make orders. There is one scenario in which you would be able to trade without interference: if you were holding an overnight over-the-counter position in which you and your counterparty were the only parties participating in the transaction.
Lack of liquidity also causes slippage and price spikes. Slippage is highly undesirable for any traders making trades since it widens the gap between the actual price and where the price was predicted based on the chart. Even worse, it can produce negative pips or gaps in price charts that traders can’t fill because they run out of funds before their order is completed.
How liquidity providers affect traders and profitability
Forex market makers boost the FX market’s liquidity by guaranteeing that there are always enough willing buyers and sellers to accommodate any amount of transactions. Liquidity providers in the foreign exchange market supply bid and ask for quotations that facilitate competitive pricing and guarantee that no buy or sell order will ever be at an unexpected price since it will always be matched with another transaction. When liquidity is constantly accessible, Forex brokers can help to decrease volatility and minimize price gaps caused when traders have to wait to close their trades. If the market isn’t honest, they can miss out on chances that might have yielded more profits had they gone with the flow.
To sum up, higher liquidity and fair competition benefit both retail traders and institutional investors.
Which market participants help provide liquidity?
Trading companies, major enterprises, and even government are all potential sources of liquidity in a Forex transaction.
1. Market makers
In order to win over trader orders, market makers compete by giving bid and ask prices that are more enticing than those of their competitors. A market maker is distinct from a broker in that they incur no risk whatsoever while delivering these quotations; rather, they serve as a middleman between buyers and sellers without ever really possessing any of the money currently in circulation. Human market makers invest their own money and offer liquidity by quoting prices unrealistically low to entice additional traders, whereas electronic market makers do the same thing.
2. Electronic dealers (ECN/STP)
Without offering price quotations themselves, electronic merchants simply forward customer orders to the lowest available vendor. Unlike placing a limit order with a broker, if there is no matching quotation, your order will wait until another trader comes along and delivers one that meets your needs better.
This is great news for retail traders since it eliminates the need for the dealer to collect a commission on your trades, resulting in tighter spreads and better overall pricing.
There are dozens of factors that depend on the availability of foreign exchange funds, but one of the most important is the ability to quickly convert one currency into another. Forex liquidity services earn money by charging a fee, but if there are no other options, you can make money off the spreads they provide. Remember, when markets are liquid, participants have more access to information and are less likely to miss out on opportunities due to price gaps.
