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Beginners Forex Education Forex Basics

Advantages of Forex Trading – Leverage, Liquidity, and Volatility

There are a lot of advantages to trading forex over some of the other methods of trading such as stocks, some of these advantages are the leverage that you can use, the liquidity in the markets, and the volatility that the markets can give. Each of these gives you a huge advantage as a trader and can help boost your potential earnings. Of course, they can also add a bit of risk to your trading too. We are going to be looking at some of the advantages of trading forex today.

Leverage

The first advantage that we are going to be looking at is leverage, but before we work out why it is good, let’s get a little understanding of what it actually is. Leverage basically allows you to borrow the money that is needed to make a trade from your brokers. It allows you to place trades that are far larger than your balance would otherwise allow you to make, this is one of the reasons why it is so sought after. So if we take a simple example, let’s imagine that you have a balance of just $100, you would not be able to place much with a 1:1 leverage on the account, so we go for a 100:1 account. This means that for every $1 that we have in our account, the broker will top it up to $100, so will add $99 themselves. So that $100 account is now acting like a $10,000 account, allowing you to make far more trades. Of course, some brokers go higher, at 500:1, 1000:1, or even 2000:1, the latter two are a little too high and the 500:1 seems to be the sweet spot.

So that is what leverage is, but how is it helpful to us as traders and why is it one of the major advantages of forex trading? To put things simply, leverage allows us to trade a lot more and thus make a lot more profits. After all, why would you trade with an account with just $100 in it when you could be trading the equivalent of a $10,000 account. You should bear in mind, that while the brokers are giving you this money to trade with, it is not yours to keep, you will have to return it, and should you lose, you may have to pay it back, although most brokers now offer negative balance protection to help this. The main advantage is that it lets you trade with more and so they can earn more in profits. Larger trades mean larger profits and that is the main advantage to it. It does come with risks, but with proper risk management it is very manageable, so do not be afraid of taking larger leverage, just bear in mind that it does come with some risks.

Liquidity

The forex markets are one of the most liquid markets in the world, this simply means that there is a lot of money available to be traded at any one time. Liquidity is basically defined as the ability for a currency or asset to be traded on demand. As the forex markets are so liquid, this basically means that you are able to trade at any given time whenever you want, and the more liquid that a currency pair is, the lower the spread cost that comes with it. With high levels of liquidity also comes a certain level of calm, the markets will not jump up and down as violently when there is a lot of liquidity in the markets, making it a slightly safer investment opportunity. While the forex markets as a whole are incredibly liquid, there are some pairs that are a little less liquid and so the spreads may be higher and there may be larger jumps in those currency pairs.

Some of the higher liquidity pairs include EURUSD, GBPUSD, USDJPY, EURGBP, AUDUSD, USDCAD, USDCHF, and NZDUSD. Some of the lower liquidity pairs include the exotic pairs such as PLNJPPY, these sorts of currency pairs cannot be purchased in huge lot sizes due to the lack of liquidity, however, with smaller trade sizes they can offer large jumps and large potential profits and losses.

Volatility

Volatility within the forex markets is basically a measure of the frequency and the size of changes to a currency’s value. If something is described as having high volatility, this simply means that that currency or currency pair has frequent movements within its market price and those movements can be sharp and large, whereas a currency that is considered to have lower volatility will simply move up and down at a more controlled pace and those movements will not be as sudden and the price is far less likely to simply jump up and down.

Both high and low volatility pairs can offer us some advantages as a trader, if we take high volatility, the profit potential of these pairs is far higher than low volatility pairs. Imply due to the fact that the markets will be moving a lot more and when they do move, they move a much larger distance. So a single trade on a highly volatile pair has a lot higher profit potential in a shorter period of time than one on a low volatile pair. Having said that, there are advantages to a low volatility pair too, they are much safer to trade, you do not need to worry about any sudden jumps in the wrong direction and they are often considered as being a lot easier to predict. The slow movements allow you to constantly analyze the markets and changing conditions, allowing you to get in and out at a much more comfortable level. Which one works for you the best will simply come down to your own preferences and your own trading style.

So that is Leverage, Liquidity, and Volatility, all three offer you very different advantages to trading forex, and combined they are the reason why forex trading is becoming so popular for both professionals and retail traders. Ensure that you get an understanding of how each one works, this will enable you to much better maintain your account and to understand the risks and advantages that you are getting from your account and the markets that you are trading. Do not be afraid to experiment with different pairs that offer different volatility and liquidity, part of being a good trader is trying out new ways to make a profit.

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Forex Money Management

Beware of the Liquidity Trap!

At present, triggering this wage-price spiral is not within the reach of the Central Banks. The Keynesians, who have not understood a word of what happens in these cases, call this situation a “liquidity trap” and give it an extremely silly explanation, such as an accidental monetary anomaly that leads to insufficient spending. 

They remember that when the economy was going well (in the Happy Twenties) more was spent but they are not able to see what relationship there was between that spending more and that the economy seemed buoyant and they are not able to understand why it is not possible to spend more now. They blame it for a lack of money, credit, and spending, although it is enough to open the window and look to see a world crushed under huge amounts of money, debt, and poverty resulting from decades of spending orgy.

“Liquidity trap” is just a superficial symptom. The central banker cannot cause inflation because he cannot make the money mass grow and this, superficially, is a consequence of the fact that it is not possible to issue huge amounts of new debt that will make the money mass grow. (The failed credit bubble causes the money stock to shrink at high speed (deflation) and the central banker has to create new debt to compensate for that contraction, to replace the money stock that destroys the unpaid credits, and, in addition, create additional debt that makes the money mass grow and dilutes the existing debt). Many analysts think that, fundamentally, it is this severe over-indebtedness of the economy that prevents creating more debt and growing the monetary mass but this is a superficial point of view. Even if all the debt were forgiven, the economy would still be stuck in a deflationary episode.

Let us remember that a spell of spiral price-wages (or currency devaluation) in which the Central Bank causes the money stock to explode evaporates debts because it evaporates savings. It is a confiscation by the State of the savings of savers to subsidize the forgiveness of debtors’ debts (and to get those debtors to consume again and the State to collect again). In this transfer of income, three parts are involved, the saver who has the savings that are confiscated, the State that forcibly imposes that confiscation, and the debtor whose debt is pardoned at the expense of the savings confiscated from the saver.

When in a “liquidity trap”, this transfer of rents stops working, the Keynesians, to explain what is the piece that may be failing and preventing the “stimulus” of the economy, look at only two of the pieces: the debtor or the State and conclude that either there are not enough debtors willing to borrow more or the inflationary policy of the Central Bank is not aggressive enough. Or, in other words, the state is not showing enough commitment to confiscating citizens’ savings or there is not enough interest in receiving the spoils of the confiscation. They always forget the third piece because they do not know that in the economy there are savers who produce and preserve the real collective wealth. They believe that wealth is produced by central banks when they print bills and by squanderers when they borrow those bills and spend them. If the economy does not come out of its agony it is because not enough bills are printed or because they are printed but not spent stupidly enough.

The cog that has stopped, the cog whose arrest is inevitable when you walk the road to poverty called Keynesianism, is of course the third piece in the confiscation and destruction of savings: the saver. No magical Keynesian accountant spell can get us out of this because it lacks the real savings that they can confiscate and destroy to simulate that they create wealth and produce.

Only genuine production (not disguised consumption of production), and savings that allow the preservation and restoration of capital destroyed in the last 50 years, can lift us out of this depression, but none of this would be possible when the economy is crushed by the Great Parasite and his high priests – shamans.

QE’s operations have failed to achieve their goal of inflation because they are a desperate measure in the face of gigantic deflationary forces and simply fail to overcome the power of those deflationary forces. The QE is not a monetary but a fiscal measure, and is, therefore, illegitimate/illegal, since tax measures can only be decided by elected representatives of a Parliament and not by senior officials (who are also deeply retarded).

The QE, as a fiscal measure, consists of a nationalisation of bad private debt. The huge holes in the banks caused by loans that could not be collected are transferred to the taxpayers’ balance sheet, in a Keynesian fantasy operation since the taxpayers will never be able to pay that debt.

The balance sheet of the financial system, which was completely bankrupt, is somewhat healthy and the debt of households and companies is reduced at the cost of an explosive increase in the debt of future taxpayers (the debt of States). In order to understand the process correctly, you have to understand what inflation is and what deflation is. Inflation is the rate of growth of short-term living debt in the system and deflation is the process of contraction of debt stock.

The price increase is only a marginal symptom, which sometimes accompanies and supposes a canary in the inflation mine but is not a fundamental phenomenon and is not always present. For example, hyper-inflationary processes in the Weimar Republic, Venezuela, Zimbabwe, or, today, Argentina occur in severely deflationary scenarios: debt/real value savings in these economies contract severely even if prices rise due to massive counterfeiting of money by governments.

Deflation, contraction of debt/savings present in an economy occur because agents repay their debts and do not go into debt again, because the agents stop saving and there is no savings to finance new credit or because the debtors are unable to meet the financial cost of their debts and those debts become uncollectible and are erased from the banks’ books.

During the onset of the last Great Depression, the current Great Depression, living debt was grossly contracted by debtors’ default. The non-payment of a debt makes that bank asset a failed one: the bank’s right to collect that debt and pushes the bank into bankruptcy, which destroys the savings of the bank’s shareholders first and the bank’s depositors afterward.

For example, a bank with deposits of 10 billion and a capital of 2 billion contributed by shareholders has lent 12 billion. That bank’s assets: its right to collect $12 billion from its debtors, allows it to meet its commitments of $10 billion to depositors and $2 billion to its shareholders.

If that bank’s debtors defaulted on $5 billion, the bank would have to erase, as uncollectible, assets worth $5 billion. Now the bank has assets of only 7 billion with which it would have to face commitments (debts) of 12 billion. The bank is bankrupt and shareholders’ savings worth 2 billion (the bank stock is listed at zero) and depositors’ savings worth 3 billion (depositors suffer a 30% cut, lose 30% of the balance on their deposits) have been destroyed.

 

Categories
Forex Market

Forex Liquidity and It’s Impact on Strategy Selection

Liquidity is often confused with volatility, but both are different concepts. A liquid currency is an asset that can be exchanged very quickly for another type of asset. We will always find many buyers and sellers in the liquid market and consequently, the spread will be very small here. But as soon as some important news is published, buyers or sellers disappear from the market, and the currency changes from liquid to volatile. However, there is no strict inverse relationship between these terms. In this summary, you will learn more about this, as well as what liquidity is, what it depends on, and much more.

What market is the most liquid? It is logical that the less liquid markets are those of antiques and collectibles, where the turnover of capital is relatively small and, more importantly, few participants. Stock and foreign exchange markets are different. The stock market is believed to be more liquid, at least because the turnover of the OTC currency market is almost impossible to assess accurately. But can you buy a stock in two clicks with 10 US dollars? And a currency? That is precisely why I believe that the liquidity of the foreign exchange market is more attractive to a low-capital investor.

In this article, you will learn:

*What is the liquidity of a currency and why a trader needs to know about it.

*What is the difference between a liquid currency and a non-liquid currency. Factors that affect liquidity.

*Strategy and liquidity. How can we choose a currency pair for a particular type of trading system.

The concept of “liquidity” can also be easily found in the financial results of companies. It means assessing the company’s ability to pay its obligations quickly. Liquidity ratios are an aid to assessing the solvency of a legal entity. We can comment on this issue separately (if you are interested, leave a comment), but this summary will focus on currency liquidity.

Use of Liquidity and Market Volatility in Strategy Building

The liquidity of one currency measures the possibility of exchanging rapidly one currency unit for another. The faster it can be done, the more liquid the currency unit is. Freely convertible currencies are considered the more liquid. The lower the country’s share of the global economic space, the greater the “regulation” of the domestic market, and the manual control of the economy, the lower the liquidity of the currency.

Simple analogy. You have US dollars on your hands. You can always quickly find someone who is ready to exchange them, for example, for euros, because both currencies are traded worldwide. You can also change them with the same ease again. USD and EUR are very liquid coins, just as the EUR/USD pair is a highly liquid pair. You can also buy Venezuelan bolivars with dollars. The country goes through hyperinflation and will gladly sell you the national currency. But then you won’t find buyers and will be forced to sell it for a penny. Bolivar is a low-liquidity currency.

In a highly liquid market, there will always be a relatively equal number of buyers and sellers (or an equal proportion of supply and demand). Liquidity reflects the interest of market participants in both the absolute number of participants and the volume of transactions per unit of time. When liquidity is very high in a market, the faster goods can be sold/purchased, and the greater the volume of transactions possible.

Simple analogy. There is a market where there are 10 vendors, each ready to give 5 euros. The buyer needs 45 euros, the market volume is 50 euros (10*5). For the buyer, this market is very liquid. If there were 3 sellers, and each would be prepared to offer 15 euros. This market can be called highly liquid, as supply and demand satisfy each other. Suppose there are only 1 buyer and 1 seller on the market. The buyer wants 40 euros, but the seller only has 10 euros at the current price. The buyer is forced to raise the price or wait for other sellers. It is a low liquidity market.

Traders often confuse the concept of liquidity and volatility. Volatility is the extent of price changes per unit of time. In a market with excellent liquidity, prices do not have very large fluctuations in one direction or another, as purchases and sales are made almost instantly at satisfactory prices. Price moves smoothly in small steps. Conversely, a low-liquidity market has frequent price spikes.

High liquidity does not mean high volatility. A high-liquidity market is characterized by smooth movement, while in a low-liquidity market the shares of large individual players can bring chaos to the movement. Why do you advise not to operate during the news outing? Because any news is subjective and liquidity providers prefer not to open operations. The loss of liquidity generates an increase in volatility (increased amplitude), a situation in which small volumes of transactions, even small amounts, can influence price.

Differences Between Liquidated and Non-Liquidated Currencies

*Small spread (the difference between purchase and sale price). If the coin is not attractive to buyers, the seller will be forced to lower the price until a buyer wants to buy it.

*Free access to information. If liquid coins are attractive to traders, so are analysts, news agencies, etc. You can find information about non-liquid currencies mainly in the original sources.

*Formation of the contribution market. Highly liquid currency quotes are defined by the supply-demand ratio (floating exchange rate). Illiquid (illiquid) currencies are often strictly regulated by central banks.

*Economic development. Low-liquidity currencies are the currencies of developing countries.

*Liquidity tends to change. Despite the fact that more liquid pairs are considered freely convertible currencies, a possible situation is when the price of a particular asset falls but cannot be sold due to a lack of buyers.

Liquidity on Forex Depends On…

*Supply and demand volumes. Large trading volumes provide the currency with a constant supply and demand. If there are, for example, few buyers in the market, the seller is forced to place a lower price to have buyers available or expect. The fewer participants negotiate, the less liquid the currency.

*Session. Trading activity, and the liquidity of the Forex market, is to some extent defined by the trading session. For example, the largest number of operations in the Japanese yen is observed in the Asian session, when in the region it is day. If we talk about the currency market in general, the least liquid in the Asian session and the most liquid in the European session.

*Key factors, including holidays. News, press releases, speeches by representatives of central banks, force majeure: all this affects, to a certain extent, the volume of trade, which also means in liquidity. The liquidity of the currency is also affected by trading days. For example, on the eve of holidays (or the holiday season), trading volumes are reduced and liquidity along with them.

*High liquidity currencies are EUR, USD, JPY, CAD, GBP, AUD and CHF. If we talk about the liquidity of currency pairs, these are all previous currencies paired with the USD, although opinions differ here. In some sources, the GBP/JPY pair is also considered highly liquid

Interesting fact. The 2008 crisis showed how liquid currencies can quickly become volatile. In addition, investor dissatisfaction with the growing US public debt that we see more and more is a time bomb. According to one version, USD liquidity may falter and commodity currencies in the foreground will emerge as the most stable (least exposed to demand and volatility). These include the Norwegian krone, Australian, New Zealand, and Canadian dollars.

Choosing a Trading and Liquidity Strategy

Should I consider the level of liquidity when creating a strategy? The question is not so clear. I will try to put the same thing in other words. Small traders often follow the trend, that is, they follow the majority led by market makers. Which market is profitable for big players in terms of liquidity? There are two versions:

High liquidity market. Excessive liquidity will serve as a buffer for the sudden formation of price spikes. In other words, large volumes liquidate sudden price spikes. This market is considered quieter because it is interesting for market makers who are used to stable pragmatic trading.

Low liquidity market. The condition when a small number of traders remains in the market is called a thin market. For example, during the holiday season or holidays. For large capitals, this is a gold mine. The less liquidity, the easier it will be to change (need less money) the price in the right direction, taking it to key levels (disrupting other people’s stop orders).

Everything depends on the situation. It is very logical that liquidity levels may affect the choice of a particular strategy, but they do not actually affect it as much. For example, the EUR/USD currency pair is considered very liquid and with average volatility. When the market is calm, it is very suitable for intraday trading and scalping, but during the news outing, its expected volatility increases sharply, thus eliminating most scalping strategies.

What is Liquidity in a Currency?

Here you can see that, despite the high liquidity in short terms, in long-term periods, the amplitude of the movement is quite large.

Characteristics of highly liquid currency pair trading:

  • Liquid currencies require the utmost attention and the ability to make decisions instantly.
  • The time period is usually short: M5-M30, hourly intervals are used less frequently.

A trader must understand microeconomics and macroeconomics, know where to get some information quickly, understand the economy and policy processes of developed countries, and know what will have the greatest impact on the exchange rate.

Highly liquid currency quotes are more susceptible to the manipulation of large capital. The larger the size of the market and the smaller the participants, the greater the possibility of creating the right news fund using the right media, analytical summaries, or statistics.

Low-liquidity currencies are suitable for two categories of traders: lovers of long-term strategies and those who trade in Forex for excitement and pleasure, so the probability of winning is low. While here you don’t need to constantly monitor the news.

Liquidity is changing, so there are no liquidity calculators. But there are volatility calculators that show the current range of price changes.

What is Liquidity in a Currency?

This calculator can provide indirect information about liquidity. For example, low volatility may indicate high liquidity at this time. On the other hand, this can mean a plane, that is, the absence of negotiation in this pair. In other words, the volatility calculator does not allow for unequivocal conclusions regarding the level of liquidity, but it can serve as an auxiliary tool.

Conclusion. Liquidity is the ability to quickly exchange one asset for another. Low-liquidity markets are not protected against sudden price jumps. They may be of interest to investors who tend to take higher risks for high returns. The main advantage of highly liquid markets is that no major player is able to influence price significantly. They, therefore, involve fewer risks and, due to greater predictability, are more suitable for technical analysis.