Your 200-year old professor probably told you that liquidity is the degree to which an asset can be bought or sold in the market without affecting its price. While there’s nothing wrong with your professor’s adage, I like to think of liquidity as an asset’s popularity.
A “popular” asset would have hordes of groupies and haters, or in geek speak–buyers and sellers. As an example, consider my twin, Brad Pitt. As a popular A-list celebrity, he would probably pay less attention to one hateful tweet than a washed up D-lister like Pauly Shore would.
Also, the positive comments from his numerous fans will cancel out any negative comments from the haters. Besides, Brad would probably be too busy minding his fame and fortune to notice such an insignificant event.
In the same way, a single buy or sell order would have less impact on the price of a highly liquid currency pair as the large pool of pending buy/sell orders would absorb puny retail orders like ours.
During the holidays (Thanksgiving, New Year, BabyPips.com day, and the like), liquidity in the forex market usually dies down because the big boys of trading usually go on vacation (i.e., take down live orders to avoid unwanted risk). This can be very problematic for small traders as it exposes them to price spikes and execution slippage.
As I’ve said in the beginning, the more liquid a financial instrument is, the smaller the effect large market orders have on price. The opposite also holds true: the less liquid a financial instrument is, the larger the impact big market orders have on price.
Now, what good would all this knowledge be if we couldn’t apply it to our trading? Let me give y’all a few tips on how to make the most of a holiday season’s low liquidity.
- Stick to the pairs that are most frequently traded, such as EUR/USD, USD/JPY, and GBP/USD. Not only are they the most liquid pairs around, but they also tend to exhibit recognizable price patterns that you may be able to capitalize on.
- Consider trading other time frames. If you want action, lower time frames are where it’s at! The hourly and 15-minute time frames can present plenty of opportunities for those who can act fast. But if you’re looking for a smooth, slow ride, then maybe you ought to consider the daily and weekly charts.
- Know which trading sessions to trade. Market players are aplenty and the markets are most liquid when the London session and New York session overlap from 1:00 pm GMT to 5:00 pm GMT.
- Be on the lookout for breakout plays. Times of low liquidity can be marked by dull price action followed by sudden, explosive movements, typically around top tier economic data releases and geopolitical news events. Stay alert and be ready to trade any breakouts that may emerge!
- …or don’t trade at all. If you’re really not comfortable trading under these conditions, then hang up your trading gloves early and get a head start on the holiday celebrations!