9. What is market liquidity? Why is the liquidity in forex market so high?

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What is liquidity?


Liquidity can be said to be the measure of the ability of an asset to convert into cash. The higher the liquidity of the asset is, the easier it is to be converted into cash, and it does not need to suffer too many unnecessary price losses due to supply and demand problems in a specific period of time.


For example, the stocks of well-known large enterprises or gold, can be converted into cash very easily because they are widely recognized in the market. On the other hand, things with low liquidity, such as fixed assets, are not easy to be converted. Take a suburban house as an example. Because the houses in the suburbs are not easy to sell, the owners usually have to go through the process of bargaining to reach a deal. In order to sell the house more quickly, homeowners often reduce the price. At this time, the loss of price and time will occur.


Market liquidity


There is also liquidity in financial markets, that is, the number of buyers and sellers of an asset in a given market. The more people involved in the transaction, the easier for the asset to be bought and sold, which is a sign of abundant liquidity. For example, because the trading volume of forex market is the largest in the world, so traders can buy and sell forex at almost any time and the price usually does not vary too much. In addition, most transactions are conducted at the market price, and the volatility is generally stable and the risk is relatively low.


。If in the market with poor liquidity, due to the shortage of the number of buyers and sellers, there is a big difference between the bid and ask price, so after the completion of the transaction close to the market price, it is not easy to facilitate the matching of the rest. This is the common phenomenon of the market with low liquidity, that is, the widening of the bid-ask spread.


The most common example is unpopular stock. Due to the lack of liquidity, it is often impossible to buy or sell it. In order to make a sale, either the buyer has to pay more or the seller has to reduce the price.The level of market liquidity reflects the activities of trading. If more people participate in the market, the volume of trading will naturally increase, and the price will not rise or drop drastically due to its large “carrying capacity”.


Why is the liquidity in forex market so high?


According to the 2019 Statistics from the Bank for International Settlements (BIS), the average daily trading volume in the foreign exchange market is nearly $6.6 trillion. So what accounts for the huge liquidity in forex market?


The forex market is closely related to the development of the global economy and the trade of various countries, including all the economic activities such as consumption and investment, that all related to the foreign currency, making the international settlement naturally quite large. Trading volumes in the global forex market are still growing in an era of rapid globalization.


Almost everyone can be a participant in the forex market, include the governments, central banks, commercial banks, financial institutions and individual traders. Due to the time difference in financial centers around the world, the forex market also operates 24 hours a day. Under the premise of lower entry threshold and lower transaction cost, the flexible operation by participants has created huge liquidity in the forex market.


Risk Warning: The above content is for reference only and does not represent ZFX’s position. ZFX does not assume any form of loss caused by any trading operations conducted by this article. Please be firm in your thinking and do the corresponding risk control. 


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