Liquidity is a very important element in financial markets as it determines the ease of buying or selling a certain asset without the price changing excessively. When liquidity is high, you can execute trades easily and with a smaller price difference, but if liquidity is low, you may experience slippage, meaning you buy or sell at a price different from what you wanted.
If liquidity is weak, you will find it difficult to execute large trades because any large order can significantly affect the price, especially during high market volatility. This leads to price slippage, poor pricing, or even failure of the trade.
To assess liquidity before a trade, there are a few things to look at:
- Trading volume: if it's high, the market is active.
- The difference between the bid and ask price: if the difference is small, the market has good liquidity.
- Depth of the order book: meaning check how many pending orders there are.
- Choose execution timing during high liquidity times.
To reduce price slippage, use limit orders instead of market orders, break large trades into smaller parts and execute them gradually, choose an appropriate timing away from strong news, and use liquidity analysis tools if available.
Liquidity is a fundamental point in risk management and execution quality, so you should always keep it in mind before entering any trade.