A markets and trading columnist for the NZ Herald

Nick McDonald: Reasons people trade forex - liquidity and volume

The 'average' forex market daily volume at 544 times greater than the biggest day ever on the NYSE. Photo / AP
The 'average' forex market daily volume at 544 times greater than the biggest day ever on the NYSE. Photo / AP

Part 1 in a series on why professional traders trade forex.

Reason 1 - Liquidity and Volume

Liquidity relates to the number of buyers and sellers that are in the market place at any one time. A market is considered liquid if there are large quantities of both buyers and sellers meaning that participants can move in and out of the market with relative ease. Liquidity is related to, but differs from, volume in that volume relates to the total value or quantity of transactions that actually take place.

The collective result of the buying and selling that takes place = volume.

The number of buy and sell orders themselves which are ready and waiting to be executed = liquidity.

A great friend of mine was a property developer in his previous life before becoming a trader. When he wanted to sell millions of dollars' worth of property, it took time... he had to advertise and search for a buyer. Now as a currency trader he can dispose of the same quantities of currency with the click of a mouse. He is trading the most liquid market in the world with buyers and sellers stacked up 24 hours a day, 5 days per week.

In this property example, the volumes might be the same e.g. selling a $2m property versus selling a $2m currency stake. The liquidity in the two markets however is very different. Forex is more liquid and easier to move in and out of.

In fact, forex is the single most liquid market in the world. No other market has the sheer numbers of buyers and sellers than forex does. Forex volumes themselves can be hard to pinpoint as there is no central exchange where transactions must take place (like there is to find accurate stock market volume data) so many of the transactions happen in ways that are not necessarily traceable. None the less, enough is known about the sheer volume of forex to know that is it the world's biggest market.

Have a think about some of these facts to surmise just how big forex is:

* The forex market averages over USD$4 trillion in known daily volume. That is USD$4,000,000,000,000.00 of money changing hands every single day.

* The biggest volume day ever on the New York Stock exchange was 10/10/2008 when collective stock transactions equalled $7,341,505,961. That puts the 'average' forex market daily volume at 544 times greater than the biggest day ever on the NYSE.

* If you take the volumes of every single trading exchange in the world - stocks, options, bonds, etc, in every country of the world and combine them all together, forex is bigger than them all combined.

How does this benefit traders?

Traders like to be able to move in and out of markets quickly, the quicker the better. A trader in physical property, cattle, wheat, or in fact anyone selling stock or goods in a shop, via a website, or any form, will typically like to sell their product and collect their revenue as soon as they can. If a property trader wakes up one day and decides to cash up all their positions then it's going to take time. If a shop owner decides to get rid of all stock then they can have a sale but it takes time to move everything and some things still might not sell. These are considered less liquid markets.

In this fast paced world a piece of news can come out that changes a trader's whole outlook in a split second. Even if a stock trader wants to cash up stock holdings then it's not always instant. For starters the stock market is open for certain hours each day and it might be closed. Secondly, depending on the liquidity of the individual stock and the size of the position to be closed, as well as the required sale price by the seller, it can take quite some time to close out a stock position. Smaller stocks especially don't tend to have buyers and sellers lined up on each side, every minute of the day. The liquidity of the forex market means there is no waiting to cash up positions and closing a multi-million dollar position in the forex market is just a mouse click away from Monday to Friday.

The size of the forex market may seem daunting to the newbie and with good reason since forex is particularly risky for the uneducated. I am not suggesting that anyone jump head first into the forex markets - people do that every day without me needing to provide a prompt. Trading forex with no education or skills is the exact equivalent of a home handyman trying to rewire their home electrical box with the power on having never done it before or someone sending their teenage child out to drive a car with no licence and worse, no driving experience. The risk is great in all cases but when it's "just our money" at risk, people are often more blasé. Please don't be blasé!

I cannot write everything in one column and will discuss more on risk management in future articles, as I have in past articles. For now just bear in mind that forex is an exciting market with a lot of potential but it is not for everyone. It has its own risks and is particularly risky for those who think it will be easy so start trading with real money and no skill.

To leave you with a quote from Jesse Livermore, a famous trader: "People who look for easy money invariably pay for the privilege of proving conclusively that it cannot be found on this earth."

Next week we will take a look at leverage in the forex markets.

- NZ Herald

Nick McDonald is a New Zealander teaching everyday people how to trade the worlds markets via his company Trade With Precision.

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A markets and trading columnist for the NZ Herald

Nick McDonald is a leading independent trader and trading trainer with a global following via his company Trade With Precision. It started back in 2004 when Nick left his 9-5 job while living in London and within 3 months of discovering technical analysis became an independent full time trader. He founded Trade With Precision in 2006 born from corporate requests for him to train retail trading clients of large brokers and exchanges worldwide. A specialist in technical trading strategy for any market and any timeframe, Nick cuts the 'nonsense' associated with traditional technical analysis.

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