The forex market is not only the largest capital market in the world, but also has the largest number of individual and corporate participants. The chief benefit of having more participants in any capital market consists of the higher degree of liquidity that usually results.
Liquidity means how fast you can turn an investment into cash. In the forex market, this conversion happens almost immediately since you can turn a spot transaction into cash in just two business days.
The desirable characteristic of high liquidity also tends to imply that a market is very efficient, with a competitive bid to offer dealing spread and the ability to absorb orders with large transaction volumes without moving the market too much in either direction.
Basically, the forex market has no equal as far as liquidity is concerned, in addition to it being open twenty four hours a day, five days a week.
Liquidity in Forex Compared to Other Markets
Trading stocks, bonds or commodities tends to offer a trader a considerably lower degree of liquidity than trading in the forex market. In addition, most of those other markets have fixed trading times and so they do not trade continuously all week long like forex.
In addition, margin requirements for stocks are 50% of the value of the stock, while commodities can be traded with a 20% margin requirement. The forex market, on the other hand, can offer a retail forex trader leverage ratios of up to 500 to one or 0.2% on some approved margin trading accounts. Also, commercial traders dealing via bank credit lines require no margin on deposit to trade forex at all.
Basically, no other capital market offers that kind of leverage, and not even trading options can a trader get that much control of the underlying security for so little funds deposited up front.
Speculative traders consider the forex market the best trading market virtually without exception, although whether trading in the forex market is appropriate for you will depend on your determination and tenacity as a trader.
Furthermore, caution must be observed when using leverage because the risk inherent in any market is that much greater with increased leverage, and so your trading account could be wiped out in just one sharp forex move. Accordingly, traders should only take risks they can afford.
Liquidity Comes From Different Types of Participants
The principal forex market participants that help provide such a high degree of liquidity to the forex market include the following general types:
- Commercial Banks – they usually provide considerable liquidity to the forex market, often acting as market makers and speculative traders.
- Central Banks – the national banks that usually also issue their country’s currency sometimes intervene in the foreign exchange markets to stabilize their currency. They might also perform forex transactions to shift their currency reserve holdings and provide considerable liquidity.
- Trans-National Corporations – companies doing business abroad also provide liquidity to the forex market, as well as large domestic corporations who buy raw materials from other countries. These participants are largely hedging their forex risk with their transactions and they add liquidity by acting as customers of large banks.
- Hedge Funds – primarily speculators who are often willing to take on large foreign exchange positions to increase their bottom line. They help increase liquidity in the forex market with their high volume trades.
- Individual Currency Speculators – ranging from high net worth individuals speculating on forex rate movements via credit lines extended by banks or currency futures, to smaller players trading online through retail forex brokers using margin. They represent an increasing group of liquidity providers to the forex market.
- Retail Foreign Exchange Brokers – Largely operating over the Internet, they provide retail forex trading accounts that can often be opened for a relatively small deposit that acts as margin or collateral. As a result of the operations of these brokers, who usually only trade forex on behalf of their customers, foreign exchange trading has been made available to a much wider audience of smaller speculators and has substantially increased market liquidity.
- Foreign Investments Managers – these participants are composed of companies which manage investments in foreign assets such as foreign stock and bonds, for example. They primarily provide liquidity to the forex market when they initiate, close out or hedge their foreign investment positions.