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NO11 - Forex Market Size And Liquidity

"Market size and liquidity are two essential aspects for trading. If there is no liquidity in the markets, it can be difficult for you to trade. You will observe abnormal prices and your limit orders won’t get filled at the price you want. Therefore, before you trade any market, it is important to assess the market size and the liquidity factors. Thankfully, the forex markets are huge and they are one of the largest markets, if not the largest market in the world. Thus, by the sheer size, there is also ample liquidity when you trade currencies. In this article, we give you a primer on the size of the forex markets and the most traded currencies. By the end of this article, you would have a good amount of knowledge about the forex markets and this will help you to understand how big the world of currency trading is."

The forex markets, as you might know by now deals with the currency transactions. With over hundreds of different economies, and thus different currencies, you can expect the size of the forex markets to be quite big.

This is indeed true. In fact, by one measure, which is the daily turnover, the currency markets dwarf just about every other market in the world. You might often hear about how big the U.S. stocks or the bond markets are. But in essence, if you take the daily transaction or the turnover, nothing surpasses the forex markets.

What makes this possible is the fact that currencies are traded over the counter. This means, unlike stocks or futures which trade and settle at an exchange, forex transactions are bilateral.

One counterparty agrees to transact and abide by the rules of the contract with another counterparty. This essentially gives a free hand for the forex markets, allowing the markets to trade globally, instead of being confined to just a particular market.

It is this size and the liquidity that comes with it that makes trading forex more better suited for both intraday traders and swing traders.

Just how big is the forex market?

In order to understand that, we need to go to the source. The Bank of International Settlements or BIS for short is the central bank of central banks. An authority in the currency markets, the Bank of International Settlements releases its triennial report on the currency markets.

The last report was released in December 2016. According to the data, for the period ending April 2016, the forex turnover averaged five trillion. Note that this is just the daily turnover. It is difficult to get correct figures on the market cap of the currency markets.

NO11 01 Forex turnover

Daily Forex Turnover, December 2016 (Source: BIS)

As the data above shows, you can see how the currency transactions have steadily rise since the past few decades. The volume of turnover in itself gives you a brief idea on the liquidity in the currency markets.

What are the most traded currencies?

Having read the above, your next question might what are the top most traded currencies in the world. For this, we again turn to the data from the Bank of International Settlements. According to the survey report, the following are the most traded currencies.

NO11 02 Currency Turnover ForexMost traded currencies in forex (Source: BIS)

You can see that the U.S. dollar dominates all other currencies, followed by the euro. The USD has such a dominance as it is the world’s reserve currency. Therefore, whether you trade commodities or transact in oil, prices are settled in USD rather than in other currencies.

The euro, which is a relatively new currency and has been operational only since the year 2000 has quickly managed to climb up the ladder taking the second spot. This pushed the yen and the Pound sterling lower as a result to third and fourth positions respectively.

How about liquidity in the forex markets?

Now that we have an understanding of the turnover and the most traded currencies, the next question to address is the liquidity. But what is liquidity in the markets?

Liquidity is nothing but the ability to convert an asset into cash quickly. In trading terminology, liquidity has to do with how quickly you can enter and exit the markets from and to cash.

Due to the sheer size of the forex markets, the liquidity is no doubt higher than any other market. But this is not always the case. To understand, liquidity, we need to understand the major forex trading hubs in the world.

The forex markets are separated into three main trading sessions.

The NY Session: This is the U.S. trading session and of course, liquidity is the highest here
The Frankfurt Session: This is the European trading session and liquidity is also high here
The Tokyo Session: This is the Asian trading session and it includes Australia & New Zealand too. The liquidity here is not that high

You can see greater liquidity and trading volumes rising when there is an overall of two sessions. This typically happens during the start of the Frankfurt trading session which is when the Tokyo markets are heading to a close of business.

Likewise, there is an overlap when the Frankfurt session is heading to a close, but the NY session just opens.

As you can see from the above the forex markets are one of the biggest markets in the world with liquidity that can dwarf just about any other market.

Read 1020 times Last modified on Saturday, 11 May 2019 12:56
More in this category: Forex Glossary / Terminology