How to find liquidity in the forex market?
In this article you are going to learn the best way to find liquidity in the forex market. At the end of this article, you know exactly what fx liquidity is, how forex liquidity works and how you can use it to your advantage. Take notes and use the information wisely. Let’s get started.
What is liquidity in the forex market?
Before we dive deeper into how to use forex liquidity, which you will learn later in this article, let’s explain exactly what liquidity is.
Liquidity means the ability for a market to be traded efficiently. That’s how I define liquidity in markets. Highly liquid markets mean transactions can be done smoothly. Illiquid markets are harder to trade as it’s harder to get an efficient fill on your orders.
You have to view it like this: if you want to buy a 1 lot, someone needs to sell you a 1 lot at that same price. If a market is liquid, there will be plenty of orders resting to fill your order. If a market is illiquid, this won’t be the case, which causes slippage in pricing. This means your order gets filled at a higher price, so you buy at a more expensive price. Of course, 1 lot is not how it really works, but you get the idea.
So: fx liquidity, or liquidity in the forex market is key to understand for efficient order flow and transactions. By analyzing areas of liquidity, you can get a great idea of the order flow and you can use that to your advantage when trading forex.
But, why is this even important to know?
Why use liquidity in forex trading?
You should use liquidity because it works and it’s essential to understanding the big picture in the markets. You see, bigger players need liquidity. The forex market is highly liquid, but if bigger players trade huge size in illiquid markets, this can become an issue. If they want to buy 1000 lots long, but 100 lots are selling to him, that’s a problem as the rest of his order gets filled at a higher price. This won’t happen often in forex, but it still can happen.
Bigger players need to play around this. How?
By splitting their orders & by trading at areas of high liquidity.
Well, how does that work?
Order splitting
When a big player in the market needs to enter a huge order, he tends to split this up. How does that work? Let’s say he needs to buy 10000 lots for whatever reason. Then he can split that order up in 500 lots, or even less. Often, they have algorithms to do this. They scale in their orders until everything is in the markets. This can be done under the radar.
Trading at areas of high liquidity
Trading at areas of high liquidity is another way bigger players can efficiently fill their orders. How does this work? Let’s say you have a trading range. Below the trading range is where people that buy often place their stoploss. The stoploss of a buyer is a sell order. If a big player wants to buy, buying when a lot of people are forced to sell is an excellent strategy. Stick around, later in this article I will show you examples of this.
How to identify liquidity in forex
You can identify liquidity in forex by looking at key levels on a chart. Let’s give you some examples. Generally speaking, you can find liquidity in forex by looking at:
Key swing highs and lows
Boundaries of ranges
Let’s investigate both of them.
Forex liquidity at key swing highs and lows
Forex liquidity can be found above key swing highs and key swing lows. Be aware that I say key, not any swing. Pick the swings that are obvious. Pick the swings that are clearly visible on the daily chart, those tend to be the best swings to trade.
Take a look at the chart below.
I have marked two key swing points that have liquidity resting. Let’s take a look at the first one, the swing low. If you look at the left point of the yellow line, you can see a clear swing low. Why is this one key?
It’s because that swing low on the daily timeframe created that impulsive up move that you can see. It’s the origin of the move. Those origins are often significant to the markets.
Look at what happens when we revisit that point again? We get a false breakout and the market goes up again. That’s forex trading liquidity. Now, why does it happen?
When a key swing low breaks, people often assume it’s a breakout. This means you get a lot of selling. Also, people see the swing low as a support level, so if they buy, the stop goes below there.
This all adds up to a lot of selling, which a bigger player can use to fill his order and to go long. That’s why you see the fake out. You can use this to your advantage. This is how forex liquidity works.
Now, let’s give you another example.
Take a look at the second yellow line, the one at the key swing high. This is also where fx liquidity is resting. It’s a key high that created a quick down move. It’s again, the origin of the move, which is important.
Take a look at what happens when we break that high? It violently goes down. Again, people assume it’s a breakout of a key high and buy. Also, people who sold it as resistance get stopped out, which creates a lot of buy orders. A bigger player can use all this buying to his advantage and use the available fx liquidity to fill his short order.
Now you know more about key swing highs and lows, but what about ranges?
Forex liquidity ranges
Now that we have spoken about fx liquidity above key swing highs and below key swing lows, let’s take a look at this liquidity forex example: ranges.
Essentially the same thing happens here in terms of fx liquidity. When you have a trading range, people are buying and selling. The stoploss of a seller often goes above the range and the stoploss of a buyer often goes below the range. Stoplosses are orders. They are liquidity. You also get people executing orders when one side of a range breaks.
So, the same principle applies here: if the low of a range breaks, there will be a lot of selling. Why? People get stopped out on their buys and sell back to the market. People sell the breakout thinking it will continue, which is an excellent spot for a bigger player to fill his long order.
Take a look at the picture below, this is a great liquidity forex example.
The yellow line is the range low. Look at what happens once we break it? The low breaks and immediately we have a violent reaction to the upside. This is liquidity in forex explained at it’s best. Despite all the selling below the low of the range, price immediately shoots up. A great indication of a bigger player absorbing liquidity to get a nice fill on his order.
The same thing can happen at the top of the range.
Hopefully you now know what liquidity in the forex market is. But, how to use liquidity in forex to your advantage?
How to trade liquidity in the forex market?
You trade liquidity in the forex market by using it as a trading bias. A trading bias is in my opinion essential for success.
Let’s say you spot fx liquidity at a key swing low and you see a false breakout of that key swing low (like the example given above), that gives you a long bias.
Why? A bigger player absorbs liquidity and you want to basically hop on the momentum of that. That’s exactly what I do on my trading. Nothing complex.
I enter as soon as I see a bigger player entering and I simply ride the next wave together with him. That’s it.
It’s up to you how you use liquidity in forex trading, but you really want to research the topic and build some rules that you can implement in your trading to make more money in the markets. You can do this alone, or you can work with me.
Working with me allows you to fast track your learning curve. Working with me opens doors to great opportunities. Working with me gives you feedback, a mentor to work with, someone that cares and someone that gets the best out of you. If that’s something you want, click here and book a free call with me.
To conclude
You have now found answers to the following questions:
What is liquidity in the forex market?
How to find liquidity in the forex market?
How to use a liquidity forex trading strategy?
Now it’s up to you to take action with the information given in this article. Did you like the article? Share it with your trading friends. Do you still have questions about liquidity for foreign exchange, or other markets? Leave a comment down below and I will help you out.