From a trader’s point of view, an illiquid market will have chaotic moves or gaps because the level of buying or selling volume at any one moment can vary greatly. A highly liquid market is also known as a deep market or a smooth market and price action is also smooth. Most traders need and should require a liquid market because it is very hard to manage risk if you’re on the wrong side of a big move in an illiquid market.
Here are the three signs to look out for:
1.GAPS WHEN TRADING FOREX
Gaps in forex vary compared to other markets. However, price gaps can occur in forex if an interest rate announcement or other high impact news announcement comes out against expectations. Gaps can occur at the week’s opening on Sunday afternoon in the US. If there is a news announcement over the weekend, then overall gaps in forex are usually less than a 0.50% of a currency’s value. A market that trades 24 hours a day like the forex market is consideredmore liquid or simply tends to have less gaps due to the continuous naturein the equities market. This allows traders to enter and exit the market at their discretion. A market that only trades for a fraction of the day like the US Equity market or Futures Exchange would be condensed into a thinner market because price can jump at the open if overnight news comes out against the crowd’s expectations.
2.THE FOREX LIQUIDITY INDICATOR
Brokers often offer a “volume” option on the chart whereby a trader can gauge the liquidity of the market. This forex liquidity indicator is interpreted by analysing the bars on the volume chart. Each volume bar represents the volume traded during the specific time period, thus giving the trader a suitable approximation of liquidity. It is important to remember that most brokers only reflect their own liquidity data and not the overall forex market liquidity. However, using a broker’s liquidity as a gauge can represent the retail market fittingly depending on the size of the broker.
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DIFFERENT TIMES OF DAY OFFER VARYING AMOUNTS OF LIQUIDITY
Short term traders or scalpers should be aware of how liquidity in forex varies through the trading day. There are less active hours like the Asian Session that is often range bound meaning support and resistance levels are more likely to hold from a speculation point of view. The major moving market sessions such as the London session and US session are more prone to breakouts and larger percentile moves on the day. The time of day that you’re likely to see the biggest moves are the US Morning Session because it overlaps with the European / London Session which alone accounts for roughly +50% of total daily global volume. The US session alone accounts for around 20% and in the US Afternoon, you will often see a sharp drop off in aggressive moves except for when the Federal Open Market Committee (FOMC) comes out with a surprise announcement which is but a few times a year.