Liquidity can be said to be a measure of the ability of an asset to be converted into cash. If the liquidity of an asset is higher, it means that it is easier to convert it into cash without having to bear too much unnecessary price losses due to supply and demand issues in a specific period of time. For example, the higher the recognition of assets such as stocks and gold of well-known large companies, the easier it is to convert them into cash. On the other hand, things with low liquidity are not easy to convert into cash, such as fixed assets, or even a suburban house. Since suburban houses are not easy to sell, they must go through a bargaining process. In order to smoothly convert the house into cash, the owner often reduces the price to sell it, which will cause price and time losses.
Financial markets also have liquidity, which is the number of buyers and sellers of a certain asset in a certain market. The more people participate in the transaction, the easier it is to buy and sell the asset quickly, which is a manifestation of sufficient market liquidity. For example, in the foreign exchange market, since the foreign exchange market has the largest trading volume in the world, traders can buy and sell at almost any time, and the price usually does not vary too much. Most transactions are concentrated at the market price, and the fluctuations are generally stable, and the risk is relatively low.
In a market with poor liquidity, due to the insufficient number of buyers and sellers, there is a large difference between the buying and selling prices offered by both parties. As a result, after the transaction close to the market price is completed, the rest will not be easy to match. This is a common performance in a market with low liquidity, that is, the bid-ask spread will widen.
The most common example is the less popular stocks. Due to the lack of liquidity, it is often difficult to buy or sell stocks. In order to facilitate transactions, either the buyer pays more or the seller lowers the price.
The level of market liquidity reflects the level of trading activity. If more people participate in the buying and selling market, the trading volume will naturally increase, and the price trend will not be prone to large fluctuations due to its greater carrying capacity.
According to statistics from the Bank for International Settlements (BIS) in 2019, the average daily trading volume of the foreign exchange market is nearly 6.6 trillion US dollars. So what is the reason for such huge foreign exchange liquidity?
The foreign exchange market is closely related to global economic development and trade between countries, including economic activities such as consumption and investment. Foreign exchange conversion and settlement of payments are naturally quite large. In the era of high globalization, the transaction volume of the global foreign exchange market is still growing.
Almost everyone can be a participant in the foreign exchange market, including governments, central banks, large banks, investment institutions and individual traders. Due to the different time zones among financial centers around the world, the foreign exchange market operates 24 hours a day. With lower entry barriers and lower transaction costs, the flexible operations of participants have created huge liquidity in the foreign exchange market.
All financial products traded on margin carry a high degree of risk to your capital. They are not suited to all investors and you can lose more than your initial deposit. Please ensure that you fully understand the risks involved, and seek independent advice if necessary.