What is the Definition & Meaning of Liquidity in the Forex Market?
Investors and entrepreneurs who are new to online forex & CFD trading are often bombarded with terminology that can be intimidating at times. It’s one of the reasons we developed our Forex Trading Glossary since we found it has helped newcomers to the FX market clear up much of the confusion surrounding the lingo around forex & CFD trading.
An example of a term that can be confusing upon first glance is the phrase liquidity. As we’ll soon discover, liquidity is a service that is an essential component for any forex broker to properly operate.
The term liquidity most likely conjures up images of waterfalls, rivers or perhaps a faucet. Obviously, liquidity in the FX market has nothing to do with either plumbing or nature, although there is some correlation in the name itself, as we’ll shortly discover.
What is the Meaning of Liquidity in the Forex Market? – The Definition of Liquidity
To get started, let’s provide a simple definition of the term liquidity in the forex trading market. As you’ll soon discover, the concept of liquidity is not as intimidating as it may appear at first glance. A basic definition of liquidity is both the pricing and execution of trades in a forex broker’s trading platform.
Let’s consider a simple analogy to further help one understand the definition of liquidity in the FX market. Imagine turning on the water in your bathroom or kitchen, only to discover that the faucet is not working. Keep this image in your mind and now think of launching your favorite FX trading platform, except when you go to check the live market rates, you discover the prices aren’t moving at all. Similar to the water faucet not working, when the prices do not move in a trading platform, there is an issue with the broker’s feed, which is the responsibility of the liquidity provider to fix.
Further Understanding Liquidity in the Forex & CFD Market
In essence, liquidity refers to the price stream that is constantly being updated in your FX broker’s trading terminal. Note that liquidity isn’t limited to forex pairs but also CFDs and even crytpocurrencies. When prices aren’t moving in the a forex broker’s trading platform, as in our prior example, then the broker is most likely having a connection problem with its liquidity provider.
It’s important to emphasize that liquidity is more than just pricing; it’s also the execution of the orders you see flashing on your screen. Simply put, order execution is what happens when a trader buys or sells any forex pair, stock, or CFD.
Once the order is placed in the trading platform, it must be routed to either a bank, hedge fund, or other clearing party which are collectively known as liquidity providers. When the LP (liquidity provider) receives the trade request, known as confirmation, it is then executed and routed back to the broker. The trader, who placed the order, will then the open trade in their platform. What’s amazing is that this entire scenario described above will happen in a matter of milliseconds!
Forex Consulting Services – Your Guide to Understanding the Forex Trading Market
We hope our definition of liquidity in the forex market helped you to better understand its meaning. If you would like to explore other terms, make sure to check out our Forex Trading Glossary where we provide helpful answers for some of the most common inquiries found when trading forex.
Finally, if you are new to trading and require guidance in selecting the broker that’s right for you, make sure to reach out to our team of consultants. We are more than happy to explore your specific needs further. We look forward to hearing from you!