How important is liquidity in stock trading?
One of the main recommendations for novice traders is the advice to trade the most liquid assets.
Liquidity is the speed with which a product can be sold at the most favorable price, that is, we can say that the greater the demand for a product, the more liquid it is.
But in modern stock trading, slightly different laws apply than in the real market, and to complete a transaction we do not need to search for a buyer or product as in real life.
How important is the liquidity of an asset in this case, can it affect the final result of the transaction, and is it really worth paying attention to this indicator when choosing what to trade on the stock exchange?
The Impact of Liquidity on Brokerage Commissions
Liquidity primarily affects the size of the commission and spread charged by the broker for open trades. The difference between similar assets can be enormous:
Let's take, for example, the most popular currency pair on Forex, EUR/USD, and the much less popular, and therefore less liquid, pair GBP/NZD.
For EUR/USD, the average spread is 0.7 pips or $7 per lot, while for GBP/NZD the spread is already 4 pips. Taking into account the exchange rate for a 1-lot transaction, when opening a transaction, you already need to pay $26 in spread.
The difference becomes especially noticeable when trading with high leverage, so it is always recommended to use only the most liquid assets scalping strategies
Compare for yourself: leverage of 1:500 and a deposit of 1000, we open a deal with a volume of 5 lots, as a result, the opening fee for EUR/USD will be $35, and for GBP/NZD as much as $130.
If you don't use a lot of leverage and plan to hold a trade for a long time, the difference in spread is unlikely to have a significant impact on the financial outcome of your trade.
It's also worth noting that due to the drop in liquidity before the holidays, spreads can increase tenfold even for the most popular currency pairs. Therefore, it's best to refrain from trading during these times.
Liquidity and risk
As a rule, trading low-liquidity assets also increases exchange rate risks. These currency pairs experience more frequent exchange rate fluctuations and price gaps.
And when buying low-liquidity securities, there is always a danger that their price will fall to a minimum.
In addition, it is more difficult to track news and find the necessary information for analysis for less popular assets, which means that trading using them will be less effective.
Therefore, the advice to trade the most liquid assets is completely justified and worth heeding.
Liquid currency pairs - https://time-forex.com/pary/likvidnye-pary
