Understanding Forex Market Size and Liquidity
The world forex is created by combining foreign currency and exchange. It simply means using one currency to buy another. However, this is not how many people understand the forex market.
Some think they have never participated in the forex market, when in fact, anyone who has traveled to a country that uses a currency other than their own contributed to the foreign exchange market.
What Is The Size Of The Forex Market?
The forex market oversees approximately $6.5 trillion in daily turnover, although the Bank of International Settlement (BIS) data shows the industry recorded a high of $7.5 trillion in April 2022. A majority of this volume comes from banks and institutional investors.
However, retail traders and local traders swapping local currency for foreign notes in the forex bureaus also play a part.
Structurally, the forex market is made up of five distinct categories – the spot market, forwards market, forex swaps market, currency swaps market, and forex options market.
Forex swaps account for the highest volume while the options market and currency swaps market are the smallest.
- Forex swaps – $3.2 trillion
- Forex spot market – $2 trillion
- Forex forwards market – $0.9 trillion
- Forex options market – $0.3 trillion
- Forex currency swaps market – $0.1 trillion
The forex market is open 24 hours a day every day of the week all year round. However, retail forex traders can only access the forex market 24 hours a day during the five weekdays.
Understanding Forex Market Liquidity
Liquidity is the term used to refer to how active a market is. The forex market is the most liquid financial market in the world. The forex market size and liquidity are measured using the daily turnover, which, according to BIS currently averages about $6.5 trillion.
To put this into perspective, it means that approximately $76 million worth of transactions happens in the forex market every second!
However, the liquidity in the forex market is not constant throughout the day. There are specific periods when the forex market is highly liquid, and others when liquidity is low. Furthermore, not all currency pairs have the same liquidity.
What Causes Liquidity Fluctuation In The Forex Market?
There is no short answer to this question because it is a multitude of factors. However, the most prominent cause of fluctuation in the forex market size and liquidity is market hours. The currency pairs traded also contribute to the different types of liquidity in forex.
Although the forex market is open 24 hours a day, different forex market sessions correspond to regular business hours across different time zones. Note that the majority of trades in the forex markets are conducted via the interbank forex market.
Therefore, liquidity is highest when banks and other businesses are open during regular business hours. Conversely, the liquidity will decrease when the business day ends.
In total, there are four forex trading hours – Sydney, Tokyo, European, and North American forex trading hours. The liquidity in the forex market varies during these trading hours.
The higher the transaction volume during a session, the higher the liquidity. Here is a snapshot breakdown of why Europe and North America represent the most liquid sessions in the forex market.
Liquidity During the Sydney Session
The Sydney forex trading hours start at 10.00 PM GMT and end at 7.00 AM GMT. The main liquidity providers for the Sydney session are banks and institutional investors in Australia and New Zealand.
The Sydney session accounts for about 11% liquidity to the market, with a majority of this coming from counter currencies paired with the AUD (Australian dollar) and the NZD (New Zealand dollar).
Tokyo Session Forex Liquidity
This trading session accounts for about 19% of the daily traded volume in the forex market, making it the third-most liquid market.
The Tokyo forex market hours are also called the Asian trading hours since it occurs when major commercial hubs in continental Asia are open between 12.00 PM GMT to 9.00 AM GMT. Currency pairs involving the JPY (Japanese yen) are the most liquid, with the USD/JPY topping the list.
North American (New York) Session Forex Market Liquidity
The North American forex session is the second largest, with about 28% of the daily trades conducted during this session. The session opens at 1:00 PM GMT and closes at 10.00 PM GMT.
Forex pairs involving the USD and CAD are the most liquid, with the USD/CAD pair ranking high on that list.
European (London) Session Forex Market Liquidity
This forex trading session, also known as the London forex trading session, is the largest and accounts for approximately 42% of the daily forex turnover in the forex market, making it the most liquid of the four sessions.
The session runs from 8.00 AM GMT to 5.00 PM GMT. Forex pairs with GBP and EUR are the most liquid during this session.
Forex Session Overlaps and Market Liquidity
Note that there are times when the above forex trading hours overlap. During these overlaps, the liquidity in the forex market significantly increases since there are more active participants in the market. Here are the overlaps.
- The Sydney-Tokyo forex trading hours overlap between 11.00 PM GMT and 5.00 AM GMT
- Tokyo-European forex trading hours overlap between 6.00 AM GMT and 7.00 AM GMT
- European-North American forex trading hours overlap between noon GMT and 3.00 PM GMT.
Of the three forex market overlaps, the European-North American overlap is the most liquid and accounts for approximately 70% of the daily turnover. The EUR/USD and GBP/USD tend to be most liquid during this overlap.
Forex Pair Liquidity
In the forex market, the major currency pairs are the main drivers of forex liquidity meaning they are perfect for day traders. They account for up to 72% of the daily trades; followed by minor currency pairs while the exotic forex pairs are the least liquid in the forex market. Here’s a breakdown of the most traded currency pairs as a percentage of the daily traded volume.
The Most Liquid Single Currencies
The USD is the most liquid currency involved in forex trading. About 88% of all forex trades involved the USD. Here’s a breakdown of the top five liquid currencies in the forex market.
The forex market derives its liquidity primarily from international trade. Countries prefer to sell products in their local currencies for accounting purposes, but more importantly, to make sure that their earnings are least affected by forex fluctuations.