FOREX PRO Weekly August 27-31, 2012
- Thread starter Sive Morten
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Triantus Shango
Sergeant Major
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sive, which market is more liquid? FX SPOT or futures?
Sive Morten
Special Consultant to the FPA
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Spot, of cause.
Triantus Shango
Sergeant Major
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thanks. which raises interesting implications re. trading strategy as regards to order size.
Marketjoy Trader
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Triantus, can you pls expanciate on this?
Triantus Shango
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Triantus Shango
Sergeant Major
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sure. imagine the following scenario: let's say you become better and better at trading. this means your equity keeps increasing. hopefully, one day you'll have so much equity (cash) that now you can open an account with a prime broker and trade like 'real money' traders. this means that your order size will be significantly larger than what you used to trade as a retail trader. we are not talking 1, 2 or even 10 lots (USD 1M) here, but more, like 100 (USD 10M) to 1000 (USD 100M) and more.
now, consider a market that cannot readily absorb a USD 100M order but needs to break the order apart into smaller chunks and find counterparts for each chunk at different price points. if the market you are dealing in is very illiquid, the potential counterparts will not all necessarily be found close to your desired price. so you will not be filled at the price you want. another way of saying this, you will experience slippage and that could be more than single digit slippage.
as an extreme example, let's say we have a very illiquid market. in such a case, you'll usually see lot's of price gaps and price jumping from one level to another without any smooth transition in between. these gaps are like air pockets, like what you can experience on a plane when the plane suddenly drops abruptly. in those gaps, there are no counterpart and you may be forced to deal at price levels you don't like because not as favorable to your ideal entry point.
also, if suddenly traders see a huge sell order coming into an illiquid market, they know that because of the sheer size of that order it's going to move the market down. so why would they want to buy at that level? they don't. so if they had standing bids, they'll just pull them down, and wait and see where it's gonna bottom to find a better entry point. but by doing so, they accelerate the price drop. and let's say you wanted to enter short some short time after the huge order got in, maybe the market is moving so fast because of all the gaps because there are not enough bids available to support the market that you won't get filled at your entry point but maybe 40 pips lower or something like that.
thankfully as retail traders we don't have to worry about that yet, and that's one advantage of retail trading.
now, that's my understanding. but i might have gotten it wrong, so sive, or anyone with more experience in this matter, please correct the above if inaccurate. thanks.
now, consider a market that cannot readily absorb a USD 100M order but needs to break the order apart into smaller chunks and find counterparts for each chunk at different price points. if the market you are dealing in is very illiquid, the potential counterparts will not all necessarily be found close to your desired price. so you will not be filled at the price you want. another way of saying this, you will experience slippage and that could be more than single digit slippage.
as an extreme example, let's say we have a very illiquid market. in such a case, you'll usually see lot's of price gaps and price jumping from one level to another without any smooth transition in between. these gaps are like air pockets, like what you can experience on a plane when the plane suddenly drops abruptly. in those gaps, there are no counterpart and you may be forced to deal at price levels you don't like because not as favorable to your ideal entry point.
also, if suddenly traders see a huge sell order coming into an illiquid market, they know that because of the sheer size of that order it's going to move the market down. so why would they want to buy at that level? they don't. so if they had standing bids, they'll just pull them down, and wait and see where it's gonna bottom to find a better entry point. but by doing so, they accelerate the price drop. and let's say you wanted to enter short some short time after the huge order got in, maybe the market is moving so fast because of all the gaps because there are not enough bids available to support the market that you won't get filled at your entry point but maybe 40 pips lower or something like that.
thankfully as retail traders we don't have to worry about that yet, and that's one advantage of retail trading.
now, that's my understanding. but i might have gotten it wrong, so sive, or anyone with more experience in this matter, please correct the above if inaccurate. thanks.
Sive Morten
Special Consultant to the FPA
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Well, you've described liquidity problems nice. Just couple of moments that I would like to add, if you don't mind.
First, large order is not neccesary leads to huge gap and other consequences that you've described. You forget about market orders. They could split and absorb even large orders.
Second, on equity market market makers usually apply such thing, when they need to buy or sell large amount of equities. For example, Goldman Sachs puts huge lot for Sell of Cisco when they need to fullfil clients order to buy a lot of equities.
smaller players see that GS starts to sell and start join him, price turns south. While GS hit their offers and bought more that he sells on large order. Later GS off his sell order. Other words GS sells his own equities to himself through other market participants and makes profit on this. Cool, right
The major problem is to catch that moment.
Another issue that I want to ask - what kind of strategy you intend to derive from illiquidity?
Futures market is also very liquid. It holds 1 pip sread in leading contract on EUR/USD. And contract is 125 K value, not 100.
Also, huge advantage of futures is a EUR/USD options with great liquidity. You can trade EUR/USD volatility, for instance and apply a lot of other different strategies.
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