Liquidity is a critical component of trading and essential to achieving and maintaining profitability. At first glance, liquidity seems like a simple concept. In reality, it is anything but simple. Without adequately understanding what liquidity is, the impact it has on trading, and how you can improve your trading by taking advantage of it, you are likely to be forever struggling to improve your results.
This post will assist you in understanding liquidity and the importance of liquidity providers in the market. The article will also consider what to look for when selecting a liquidity provider.
What is Liquidity?
The ability to quickly enter or exit a market with no major impact on the price of that market is called liquidity. It is the lifeblood of any marketplace. For instance, if someone wants to buy 100,000 shares of stock XYZ Corporation, they will have no problem finding an available seller at most times, as many other traders want to buy and sell that stock. The moment you take one of them out of the market (by buying their shares), another trader is willing to step in and replace them (by selling shares). This describes liquidity.
The liquidity of a Forex order or trades directly impacts your trading profitability. If it is possible to enter and exit a position quickly, you will be more likely to take advantage of smaller, more short-lived price movements that can provide profits even on smaller accounts. Conversely, having access to liquidity on quick, large orders can help you take advantage of more significant price movements that are possible when trading higher timeframes.
Who are Forex Liquidity Providers?
Liquidity providers are financial institutions that allow you to enter or exit a Forex transaction swiftly. They provide FX liquidity by standing ready to buy (take your order) or sell (fill your order). If you were to place an order for 100,000 shares of stock XYZ Corporation to be bought at market price, someone must be ready to sell that stock immediately at market price. This role – to take on the other side of the transaction – is what liquidity providers do.
Why Forex Liquidity Providers are Necessary
The short answer is that they provide a marketplace. Without this marketplace, there would be no one willing to take the other side of your trades, and you wouldn’t be able to execute any orders.
Selecting an Exchange with the Best Liquidity Provider
One of the surest ways to find an exchange with the best liquidity provider is by looking at their volume numbers over varying timeframes, as well as their spreads. You want to open two or three accounts with different brokers and see which one gives you the best results. In addition, it is also good to review your own trade history and see if any of them have provided you with better or worse liquidity than the others.
When identifying the best forex liquidity provider, it is also essential to see if the provider adheres to the industry standards. Several different industry groups set guidelines on how providers should handle various aspects of their business. One such industry group is the National Futures Association. Providers must follow all applicable financial regulations, including having adequate capital reserves to cover all client trading activities, and adhering to strict risk management standards. FX liquidity providers that violate these rules can face fines or disbarment from their respective industry groups.
Liquidity in Forex is just as necessary as it is in any other financial market. It’s the reason why traders can enter or exit trades so quickly. Without liquidity, it would be challenging for traders to take advantage of the smaller price moves available throughout the trading day. The availability of liquidity will differ based on the type of trading account, the size of your trades, and which liquidity providers you have access to. Proper research will allow you to select an exchange with the best Forex liquidity provider to maximize your profits.