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Lesson 6: Volatility, Volume, Liquidity

Volatility, Volume, Liquidity, Forex

Volatility, Volume, Liquidity, ForexWe have seen in the previous article how to place a trade. Summarised, we have to decide whether to go long or to go short. If we go long, we buy the currency pair at the Ask price; if we go short, we sell the currency pair at the Bid price. The difference between the bid and ask is the spread and represents the commission we pay to the broker.

We have also seen the main types of order and what are the stop loss and the take profit. To complete the argument, we need to see how, practically, we place the trade on the platform.

Now I want to treat some concepts that I consider very important, and I want them to be clear.

 

Leverage

Let me briefly talk about the leverage in Forex, although we have already seen it in the second chapter. The leverage is an instrument that brokers offer for opening positions with a much higher value than the amount invested by the trader.

If you are dealing with a 100:1 financial leverage, it means that to buy a $ 100,000 of a currency is enough $ 1,000 (100,000 divided 100); the broker puts the rest. So, if the investment turns out to be correct, you can enjoy more large profits, but if the investment turns out to be wrong, the damage is unlimited, as the risk does not match the figure imposed by the money management but amplified by the leverage.

Financial leverage can be defined as an investment strategy based on which money may be borrowed. The leverage is, in fact, a loan that the broker gives to the trader. It is used to guarantee in the Forex the ability to make investments even if the margin required on the account is no longer guaranteed.

It does not matter if your broker gives you leverage 100:1 or even leverage 400:1. And it does not matter if it tells you that you can also open an account with $ 50 or $ 100. The biggest failing cause of a trader is because does not understand how the leverage works in Forex (and he does not know what the money management is).

An example. As for the Forex, thanks to the leverage, you can control $ 100,000 with just $ 1,000. In this case, you have a 100:1 leverage. That is, you put us $ 1,000 and the broker "lends you" $ 99,000. It looks great, does not it? Imagine now what happens if your trade gains 1%. You obtain 100%. You have put $ 1,000, and you have earned $ 1,000 more! It is great.

Naturally, everything works oppositely as well. If you check $ 100,000 with just $ 1,000, and the trade loses 1%, you lose your $ 1,000. How fast does a Forex trade gain or lose 1%? It depends on several factors. If there are important news or decisions by the Central Bank, it could be a matter of a handful of minutes.

Hence, leverage can be a positive factor if you use it correctly, but nefarious for your account if you do not know it well.

 

Volatility

Currency pairs are all, to a lesser or greater extent, volatile. Volatility can be understood as a variation of price in a certain period of time: it is not said that this feature has to be negative, in the sense that for understanding it, it is necessary to consider the aim of the trading.

In essence, volatility corresponds to the fluctuation of the exchange rate of a specific currency: this is a value that is very important for medium and long-term monitoring of a certain trend. Analysing it, we can understand whether it is worth investing or not. The greater the volatility is, the more the exchange rate value may increase or decrease. In a high volatility condition, in a relatively short time span, the price of the currency pair may vary, even in a significant way, both in one direction and in the other.

On the other hand, low volatility corresponds to a modest oscillation rate, which results in a constant variation over the period considered. There is also talk of volatility for identifying and quantifying the currency pair risk over a period of time: volatility can be expressed through an absolute number or a percentage. In short, talking about volatility means having to do with the risk that Forex involves.

 

Volume

The volume allows you to understand and know more closely the market. When a significant number of exchanges are completed over a given period of time, it means that many buyers and sellers have focused on a certain price. Better traders are those who can identify the times of calm when there is consolidation because they are characterised by smaller volume.

The volumetric indicator, very simply, tells you how much a particular currency is exchanged over the time period considered, which can be a full day or a specific time. Typically, the study of the volume is useful when adopting high time-frames, that is when long-term analyses are performed. From reducing the time-frames, therefore, is more likely to derive false signals from the volume.

 

Liquidity

Another important aspect is the liquidity. Liquidity in Forex is the amount of purchase and sale volume considered at a specific time.

Unlike traditional financial and commercial exchanges, which represent the entire volume handled, Forex plays a very important role in speculation: that's exactly the reason why we talk about "speculative liquidity". Most of the trading volume in Forex comes from traders who buy and sell taking into account the price fluctuations considered in the day.

From the high level of liquidity of Forex, results in considerable ease in purchasing and selling currencies from anyone. A liquid market, which is precisely the Forex market, makes sure that somewhat significant volumes of exchange have a low impact on price fluctuations. For an investor, as is evident, this is an advantage that cannot be underestimated, as it affects the ease with which the price may change in a certain amount of time.

Forex, in short, is characterised by average daily volumes that cannot be compared to those of other financial markets. For this reason, the currency market has exceptional liquidity that captures the attention of the trader that intends to speculate on the fluctuations in the exchange rates of currency pairs, attracted by the possibility to find, without difficulty, a counterparty interested in trading.

 

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