Liquidity, Slippage and Swaps
Welcome to Liquidity, Slippage, and Swaps! In this video, you will learn liquidity, price slippage, and swaps.
Liquidity
Market liquidity refers to a market’s ability to buy or sell an asset quickly and without significantly changing its price. Liquidity is a crucial element of any financial system. Liquid markets are characterized by high volume and assets that can be traded without significantly influencing the price. Illiquid markets are characterized by low volume and assets cannot be traded without influencing the price.
The Forex market is the most liquid market in the world. The US stock market average daily turnover is $ 220 billion while the Forex market average daily turnover is $ 5.3 trillion. Liquidity fluctuates as markets across the globe open and close, with the period from 13:00 to 16:00 GMT being the most liquid, when London and New York are both active. Liquidity is different for each currency pair, but EUR/USD, USD/JPY, and GBP/USD remain the most traded pairs and witness the most volume. While a liquid market is known for its steady movements and fixed prices, illiquidity can lead to high volatility and price slippages.
Slippage
Slippage is the difference between the price you expect to pay and the actual price at which the trade is executed. Slippage is more likely to occur when liquidity is low. For example, during news events, due to a lack of either buyers or sellers. Slippage can sometimes be in your favor or go against you. If you place a trade to buy the EUR/USD at 1.1950 and the trade is actually executed at 1.1960, the slippage is 10 pips against you. If you place a trade to sell the EUR/USD at 1.1900 and the trade is actually executed at 1.1905, the slippage is 5 pips in your favor.
Swaps
When you trade Forex or CFDs with leverage, you are either borrowing or lending an asset. For this reason, interest is paid on the borrowed asset and earned on the purchased asset. This is called swaps. As a result, the trader must pay interest on the asset that they will borrow and will earn interest on the asset that they will buy. A rollover fee, or a swap, is charged when the trader keeps an open position overnight. The rollover or swap rate is the interest rate differential between the two currencies of the pair that is traded.
Calculating Swaps
If the interest rate on the lent asset is higher than the interest rate on the borrowed asset, the trader will receive swaps. When you buy USD/JPY, in essence, you borrowed yen to buy dollars. If we assume that interest rates in Japan are 0.25% and 2.5% in the USA, the trader will earn 2.5% per year on his $200,000 and will pay 0.25% per year on the Japanese Yen.
To calculate the swaps, we simply multiply the traded amount by the difference in the interest rates. For the above long position of $200,000, the trader will earn $12.32 every day. If the rate on the lent asset is lower than the interest rate on the borrowed asset, the account will bear a rollover debit. When you sell USD/JPY, in essence, you borrowed dollars to buy Yen.
Now if we consider a short position of 200,000 USD/JPY, the trader will pay $12.32 every day. Although the market is closed on Saturdays and Sundays, banks still calculate interest on positions held over the weekend. Therefore, positions held after Wednesday 22:00 GMT will be charged the swaps for 3 days.
Recap!
Liquidity | A market’s ability to buy or sell an asset quickly and without significantly changing its price. |
Slippage | The difference between the price you expect to pay and the actual price at which the trade is executed. |
Swaps | An exchange wherein interest is paid on the borrowed asset and earned on the purchased asset. |
In the next video, we will talk about Fundamental Analysis. Thank you for watching!