A new trader preparing to set out on his trading journey begins to familiarize himself with the language of the markets and comes across various terms that have very little meaning to him at that stage. As he moves along, though, he realizes their importance and place in trading. Two of the most widely used terms, both in words and actions, are liquidity and volatility. As the trader moves along he realizes that there can be no successful trade without truly understanding these two terms.
So what exactly are liquidity and volatility? How should one use them to advantage in trading?
Simply put, liquidity may be defined as the ability of the market to easily facilitate the buying and selling of a particular instrument without causing drastic movements in the price. Hence if there are a sufficient number of buyers for a particular instrument at a particular price and a sufficient number of sellers for the same instrument at the same price the instrument may be considered liquid. A trader or investor may easily be able to buy or sell an instrument at his desired price and desired quantity since there is a sufficient number of sellers and buyers to facilitate him in doing so.
Consequently, when there are not sufficient buyers and sellers in the market to easily facilitate the buying and selling of a particular instrument at a particular price, it causes great fluctuations in the price of the instrument. These fluctuations in price are termed as volatility. A trader or investor who wishes to buy a particular instrument at a particular price may not find a seller at that price and vice versa. He will then be forced to buy and sell at a higher or lower price.
Thus, whilst filtering an instrument for trade, it becomes imperative to choose an instrument that is highly liquid and enables the trader to execute his trading plan smoothly without any eventualities. His orders will get filled in with ease and he will obtain the desired profit or exit at a predetermined loss. On the other hand, a volatile instrument may give him the desired price movement but may not allow him to enter and exit at his desired price thus causing the un-called for losses.
Financial markets are constantly manipulated by the big players who thrive on the mistakes of the small players.
It is thus a matter of great wisdom to consider these factors whilst planning and executing one’s trade successfully.