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What is Forex Liquidity and Volatility?

Forex liquidity and volatility have a significant impact on each other. High liquidity leads to low volatility due to the less fluctuation in the prices and vice versa.

Since the foreign exchange market is one of the most liquid markets in the world, it is not too volatile due to the high liquidity. But that doesn't mean there is no volatility at all. The forex market does witness fluctuating volatility from time to time as the currency pair prices change almost everyday. Let us understand what Forex market liquidity and FX market volatility are and how important they are in the forex market.

What is liquidity in Forex?

Liquidity in Forex is the ability of a currency pair to be bought and sold in the forex market without majorly impacting its exchange rate. When a currency is easily bought and sold without a lot of fluctuation in its exchange rate, it is considered a liquid currency.

When it comes to understanding Forex liquidity, there are two things you should always remember:

• The major currency pairs are the most liquid
• The exotic currency pairs are the least liquid

What causes liquidity in Forex trading?

1. Expansion in a monetary policy

Any changes in the global monetary policy affect the foreign exchange rate, and hence, the liquidity. When a country decides to expand its monetary policy to increase the money flow in the nation, the incomes and demands of the citizens are increased. This leads to a lowering in the exchange rate by depreciating the domestic currency. This is a result of low-interest rates and a high money supply. The fall in the domestic currency price leads to higher liquidity for that currency in the market with a surge in buyers.

2. Increase in global credit supply

When the global credit supply increases, implying that more loans and borrowings are provided to the people, the Forex liquidity is affected positively. A higher credit supply leads to more money in the hands of traders and investors who then invest in the Forex market by buying currency pairs, increasing its liquidity.

3. Decrease in global credit demand

When there is a decrease in the global credit demand, it means that people already have enough money to invest and trade. Hence, they do not require more credit in order to invest in the foreign exchange market.

This is how a decrease in the credit demand globally leads to increased liquidity in the Forex market. However, if the credit demand increases worldwide, it poses a situation of people not having enough money to put into investment arenas, depicting less liquidity while Forex trading.

What is volatility in Forex trading?

Forex volatility measures the frequency of change in a currency's prices. The higher the volatility of a currency, the higher is the risk involved in trading that currency in the Forex market. However, if you trade highly volatile currency pairs, you also expose yourself to incredible returns.

• The major currency pairs are the least volatile
• The exotic currency pairs are the most volatile

What causes volatility in Forex?

1. Interest rate changes

Any change in the interest rate affects the Forex market's volatility. An increase in the interest rate in an economy will mean that investors are going to cut back on their spending. Hence, the domestic currency price would substantially drop, causing high volatility in the Forex market.

Similarly, a fall in the interest rate would enable the people to spend more as they will have more money in hand, leading to the domestic currency price appreciation in the market again, leading to high market volatility due to the price fluctuation.

2. Economic shocks affecting supply and demand

Certain domestic shocks like a change in the taxation policy or a sudden surge in the prices of oil can also adversely affect the Forex volatility. For example, suppose a country goes through a hefty imposition of tariffs on trade, impacting a heavy chunk of the population (consumers) negatively; in that case, it will reduce the participation of the population into the Forex market, decreasing the currency pair prices, leading to volatility.

Similarly, if the prices of oil increase in a domestic economy (due to excessive demand), it could lead to an appreciation in the prices of the gulf countries' currencies, as now they will be supplying more oil and receiving higher incomes, again leading to high Forex volatility in terms of international currencies.

3. Global changes and events

Several global changes and events like a political election, natural disasters, wars, and similar occurrences can affect the Forex market volatility to a great extent. For example, if a country has elections coming up, most traders will not opt to invest in that country's currency since a government change is looked at as a change in the political sentiments of the nation which can introduce volatility in the market.

How do liquidity and volatility affect each other?

Forex market liquidity and volatility are directly related. The foreign exchange market's liquidity impacts the market prices as well, leading to a volatile or non-volatile market. When the liquidity in the Forex market is low, it results in a much more volatile market sentiment, causing prices to change rapidly.

However, when the Forex market is highly liquid, the market becomes less volatile, wherein the currency pair prices do not fluctuate as much and are considered stable and risk-free.

Bottom line

Understanding the Forex market completely is essential if you wish to invest in volatile currencies and make significant profits. However, if you are a beginner, we recommend you to invest in highly liquid and not too volatile currencies as they come with much lesser risk and decent profits. You should also keep a close eye on the regular updates to be aware of the factors that affect the Forex liquidity and volatility and make successful trades accordingly.

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Common Forex Trading Mistakes

Traders across the globe love the Forex market around the world for various reasons. With more than $5 trillion traded every day, it is open round the clock 5 days a week. It is a stable market for brokers to leverage trades and liquid enough for traders to profit from the dynamic exchange rates.

However, the market is also highly sophisticated and dynamic that witnesses changes on a daily basis due to multiple reasons, big or small. Traders who rush into the market without having proper knowledge about it end up making common Forex trading mistakes that cost them a dime. These mistakes can end up emptying their entire account, leaving them with nothing if the traders risk too much. It is imperative for them to resist temptation, have a solid risk management strategy and average out any critical position when possible. Only then, a Forex trader can sustain in the Forex market and make substantial gains.

Let us look at one of the biggest mistakes that Forex traders make during Forex trading:

1. Not having a well-researched trading plan

Why Forex traders lose money also highly depends on the Forex trading plan traders build. Every Forex trader needs a trading plan, and more so, a well-researched one. Trading without a plan indeed leads to losses, so it is essential that you sit down and make a list of rules that you must follow as your trading guide. The strategy should also include money and time management strategies covering questions such as:

When should I enter a trade?

What is my trading motive?

What type of currency pairs am I going to focus on?

When should I exit the trade?

When to set a stop loss trade?

What is my risk capacity?

How much money can I risk on individual trades?

What is my total budget for trading?

2. Trading without a stop loss

Not many traders are aware of the advantages of a stop loss. A stop-loss order is an offsetting order that helps you in getting out of a trade if the price moves drastically against your specified amount. This prevents you from heavy losses. You take a large portion of the risk out of the investment by having a stop loss and only risk the amount that you can actually afford to lose in the future.

3. Inadequate research

The Forex market is highly volatile depending on several factors. These factors are generally built on interconnected dynamics ranging from economics, politics and market fundamentals. All these facts converge and create opportunities and risks for the traders accordingly.

Potential gains lure traders to trade and risk more, but they often fail due to inadequate and inefficient research. This is how they lose money since they are not aware of the market conditions, the country's political instability, and economic conditions about the country of the currencies they are trading in.

To become a successful reader, one needs to read regularly, be aware of the ongoing conditions, and educate themselves about strategies that help one through potential market movements. Some critical areas one should know about are:

How are the interest rates of a country affecting a currency pair?

What is the economic condition of a country in terms of employment rate?

What are the technical indicators affecting your trade?

Is there a political mishappening in a country whose currency you are trading in?

Is the government going through a crisis whose currency you wish to trade-in?

What is the latest economic, financial and political news worldwide?

4. Hoping bad trades will turn good and continuing in the same trade

One of the grimmest mistakes a trader makes is averaging down instead of averaging up. They invest more money in a losing trade just in the hope of the trade reviving and turning good, without considering that not every falling currency pair will rise. The addition of more amounts in the bad trade elevates your losses. Holding onto such positions prevents you from shifting your capital to a more successful trade and instead leaves you with heavy losses.

5. Emotion-based trading

Emotions are the most common thing that acts as a hurdle in any type of trading. It often leads to irrational and unsuccessful trading that results in losses. Emotional trading can occur due to a personal liking towards a particular country or currency, a decision made based on what your family member told you about the currency pair, or through anticipated conclusions, you make consciously or unconsciously about the currency pair.

Such trades have no educational backing and lack proper research, technically and fundamentally. It is imperative that you devise a trading plan and follow it to avoid emotional trading mistakes made by traders.

6. Exiting from the trade too quick & missing out on considerable gains

Every trader wishes to minimize losses and maximize profits. However, many dimmish returns by leaving a trade too quickly by taking little profits. No trader should hold onto a position for too long or exit too quickly, as that prevents them from potential gains.

Exiting quickly every time saps your earning potential, and they miss out on gains. This can be due to fear in the trader's mind or greed, forbidding them from evaluation rationally. A clear and well-thought trading plan is the only thing that can help traders from making this mistake.

7. Risking more than your risk appetite

Risking more than one can afford is a common Forex trading mistake that traders make. The Forex market looks alluring to new traders, and little gains make them greedy to invest and risk more. However, this leads to heavier losses in the future when there is a negative impact on the currency. A higher risk means greater chances of the entire Forex account getting emptied in one go, leaving the trader with nothing. Setting a maximum percentage of their total capital that they can risk is an excellent strategy to ensure that you do not risk more than you can handle.

8. Trading from scratch and going all-in at once

Directly jumping into the Forex trade is a risky affair. Before you trade your real hard-earned money, it is intelligent to open a Forex practice account. You can cause the virtual funds to try trading plans and strategies, understand how the market works and the strategies that work the best for you. This way, you also get a hands-on feel about the trading platform. This gives you a chance to see how you react to trades that do not do good and learn from your mistakes so that when you invest your actual hard-earned money, you minimize your losses.

Conclusion

Everybody makes mistakes, especially beginners. It is okay to make a few mistakes, but it is imperative that you learn from them and do not repeat them. A trader needs to be aware of these common mistakes as that will help them prepare better, minimize errors and reduce losses. This also allows the trader to boost their returns when they already know their mistakes and act accordingly. If you are interested to learn more about Forex trading and the platform, our Forex trading platform teaches you everything with practical implications and real-time monitoring of the funds!