The liquidity describe a degree to which an asset bought or sold easily and quickly at its intrinsic value and converted to cash. Cash is considered universal liquid asset because it is quickly and easily converted into other assets, while tangible assets like collectibles, real estate and fine arts are all relatively illiquid. Usually liquidity is measured by taking the volume of traders and pending trades on market. It measures the ratio of buyers and sellers and whether transaction can take place effortlessly. The market is considered liquid when there is high demand and supply of an asset. In such market condition, it is easier to find buyer and seller. Marker is illiquid when there are fewer market participants.
The liquidity had great impact on financial trading market, because a liquid market is usually allied with low risk. A liquid market attract more buyers and sellers, which adds to the promising market conditions. In liquid market, seller finds a buyer quickly and easily without having to cut the price of an asset. Liquidity is also an important feature in defining the spread that a broker or trading platform provide to traders.
In forex trading market, high liquidity means there are great number of buyers and sellers to buy and sell in market. The high liquidity increase the probability that any buyer is happy to accept high price and any seller is happy to accept low price, both high and low prices move close together. In liquid market, the bid ask spread is tighten while in illiquid market, bid ask spread is widen.
In financial trading market, liquidity is measured before taking any position of buy or sell, because illiquid market is often allied with bigger risk. One thing traders must need to remember is that, financial trading market liquidity not remains fixed but it is self-motivated, continually shifting from high to low and low to high. The liquidity of current market depends upon two factors, time of day and volume of traders. Usually Asian market session is considered illiquid due to fewer participants while European session is considered high due to high volume of traders.
As compare to other trading markets, forex is considered most liquid market in the world due to great number of trading volume and frequency. A currency pair is considered liquid when it is easily bought and sold and there is substantial amount of trading activity for that pair. In forex trading currency pairs such as EUR/USD, USD/JPY, GBP/USD, USD/CHF, USD/CAD, AUD/USD, and NZD/USD are considered most liquid. In forex, liquidity matters because it tends to lessen the risk of slippage, gives quicker execution of orders, and tighter bid-offer spreads.