Paul L181 Johnson#85

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What is liquidity risk in forex and how do institutions mitigate it?

Liquidity risk refers to the possibility of not being able to enter or exit trades at desired prices due to insufficient market depth or a lack of buyers/sellers. In forex, liquidity risk is higher during off-hours, low-volume currencies, or during market shocks. Institutions mitigate liquidity risk by diversifying across multiple brokers, using aggregation algorithms, and managing exposure during low-liquidity periods (e.g., avoiding the 5 pm to 7 pm UTC window). Retail traders can avoid liquidity risk by trading major pairs (EUR/USD, USD/JPY) during peak liquidity hours, and using limit orders to control entry and exit prices. Benefits: minimizing slippage and ensuring favorable fills. Risks: trading in illiquid markets increases costs and execution times. Understanding liquidity risk helps traders ensure that trades are executed at fair prices, even during volatile conditions.