Liquidity is the name given to the convenience of converting financial products such as real estate, securities, foreign currency into cash. If a financial product is converted into cash without losing much of its value, it can be said to be liquid. In other words, if you can convert a security deposit into cash whenever you want and there is no problem in demand, that product is liquid. Products that are difficult to convert into cash are illiquid products. These products can lose a lot of value when they are converted into cash.
The most liquid asset is money. Money is the tool we use most for shopping and commerce in our daily life. We can use the money to buy goods and services whenever we want without the need to convert it. Converting assets such as homes and cars into cash can be difficult. Therefore, they can be sold for different values than their actual value when converting them into cash.
What Is Liquidity in the Forex Market?
Having more cash in a country is an indication of high liquidity in that country. When there is a lot of cash, it means that a lot of transactions are made in cash. On the contrary, the lack of cash and the high number of transactions indicate that the liquidity is low in that country. In countries, it is important to have sufficient cash in order for the economy to be balanced.
When we look at the Forex market, we see that it is a highly liquid market. Forex market is the largest volume market with the most transactions in the world. The fact that it is easy to invest, the forex trading hours are 5 days and 24 hours, it has the ability to make instant transactions, the ability to make two-way transactions, the leverage feature and the ability to turn it into cash at any time make the forex market attractive. In this market where liquidity is high, each product has its own liquidity ratio and varies from product to product. We can look at the spread rates to learn about a product with high liquidity. If the spread rate of the product is lower than the others, the liquidity of that product is higher.
When investing in Forex, it is also important to look at whether the brokerage firm is a liquidity provider. Because the liquidity provider provides its investors with the opportunity to invest at real prices. The liquidity provider firm often offers lower spreads than other firms.
Why Liquidity Is Important?
Before investing in a financial product, security or currency, investors measure the liquidity and earning potential of that financial product. These metrics protect the investor from making a risky trade. Since an asset with high liquidity can be easily converted into cash, the probability of making a profit is also high.
The concept of liquidity is important for companies. They prefer equipment and securities that they can easily get rid of in any trouble they may encounter. Assets with high liquidity are sensible investments for companies so that there is not much loss in value.
Another important point is that companies benefit from liquidity in terms of providing confidence and guarantees when borrowing. The lending institutions want to trust the borrower, to guarantee themselves, and accordingly, they want favourable terms. At this stage, lending institutions examine the securities, real estate, and products of the borrower company that can be converted into cash, and take into account the liquidity ratios. If a firm’s products with high liquidity are sufficient or more, it has a high chance of borrowing.
Liquidity comes in two different types. These are real liquidity and technical liquidity.
Real liquidity shows the assets that a firm or business can pay off if it ceases to operate. In other words, when a company goes bankrupt or goes bankrupt, it means the ability to pay off its debts by disposing of cash, other equipment, machinery, and real estate.
Technical liquidity shows the cash and other assets that a firm or business has to pay when debt is due. In other words, real liquidity considers the bankruptcy of the firm; technical liquidity considers the firm’s debt that is due.