Yields, risk and liquidity in forex markets

In his currency portfolio choices, a good trader should not only look at the expected return of a currency but also at its risk and liquidity characteristics. If, for example, the yield of a currency varies very unpredictably, traders may be reluctant to invest in it. For example, since the pound has become a volatile currency after the Brexit referendum, traders may be reluctant to hold accounts in sterling, even when the rate of return (expressed, for example, in dollars) is higher than that of a dollar deposit.

The definition of “currency risk” is, however, very controversial among traders. Many of them, in deciding which currencies to trade, are influenced by liquidity considerations. Certainly, the choices regarding the risk profiles of a speculative trader are different from those of a trader of a multinational company engaged in international trade. It should be taken into account that the most liquid markets are those in which currencies widely used in international trade are negotiated. Among them is the dollar, which is the most widely used currency. Then the euro, the yen and the pound. The crosses for these four currencies have a very high degree of liquidity, especially the EURUSD, which is the most liquid pair. For this pair, it is always possible to find buyers and sellers on the market in large quantities. There are currencies, however, such as emerging or developing countries’ ones (African and South American mainly), which are little used in international trade. For this reason their liquidity is low and it is advisable to study them thoroughly before trading them.

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