There are many foreign exchange (Forex, FX) tools that can be applied. One of them, which enjoys the highest popularity among investors, is spot currency trading. Its popularity can be shown by the fact that more than 1/3 of the investment activity is done through this tool. It also represents one of the most liquid markets in the world resulting in more than $1.5 trillion in volume each day.
The majority of forex trades are executed through the use of G-7 currencies. They are commonly referred to as the majors.
Liquidity, which refers to the easiness of entering and exiting a particular position, provides many benefits. One of them is the inability to manipulate the market.
As compared to the thin stock and futures markets, which can be easily influenced by specialists, market makers or other institutional buyers, foreign exchange markets can be hardly affected. This can be only done of banks and other financial institutions embark on heavy trading activity.
However, if attempted, the manipulation of the FX spot market will be marked with lack of success.
In order to measure the liquidity of a market, the following tools can be applied:
- Daily volumes traded
- Number of transactions
Aside from market liquidity another factor should be taken under consideration, namely volatility. The latter represents the fluctuations that are experienced in the daily prices of securities and other investment options. Volatility is regarded by many investors as a positive characteristic of a market.
However, if a market is characterized by low volatility, it may indicate a liquid market. On the other hand, if the market is marked by high volatility it may result in a less liquid market, which may be highly unbeneficial to small active traders that follow a short term trading strategy.
A significant movement on the market can be experienced if a large number of transactions are executed and the market is characterized as very volatile. However, despite the large number of transactions that is made in a forex market, prices tend to move in small paces. It has been proven that protection against too much volatility has been provided through the forex volume.
Since spot forex is available for 24-hour trades, it represents the preferred place for trade execution by active event traders. This is caused by the fact that currencies never get a rest.
Another advantage of the spot forex is that it is not limited to a particular geographic location. Additionally, the continuous nature of the forex spot market minimizes and sometimes completely eliminates the gaps in the market itself.
This means that the spot forex market doesn’t have an opening and closing days that may result in price differences. In contrast, equities and futures markets do end their operations, which usually result in different prices on the following trading day.
This directly reflects on investors that leave a position opened at the end of the trading day, since they expose themselves to higher risk levels that result form the possibility of the market opening at a significantly different price.
This is usually caused by the issuance of news at the end of the trading day. Since the market ceases its operation, the investor with an opened position lacks the ability to react to the news and adjust his/her investments. Such investors fall a victim to illiquid markets.
This hazard is eliminated from a spot FX market since it is opened 24 hours every day. Thus, investors that trade on this market are exposed to lower levels of risk.