It is not just economic events that cause market volatility. Price action is also governed by transactions or rather large amounts of money that are injected into the market. This affects liquidity in the market. The understanding of the delicate balance between supply and demand is one of the most important aspects of forex trading, factors that affect market liquidity. Market liquidity occurs when currencies can be bought and sold without a significant price change.

Contrary to the popular belief that what affects liquidity is a large number of purchasers compared to market sellers, the truth is that market liquidity is affected by market orders. When people execute market orders they allow their trades to be executed immediately. This would remove market liquidity. Market orders are then linked to pending orders, that is to say, someone who wants to sell in the market.

When market orders are larger than the corresponding pending orders, only a portion of them is filled out, leaving the remainder unfilled. In this case, in order to find new pending orders, the demand must push higher. And the pending orders effectively add market liquidity. Retail traders do not typically place very large orders which can affect prices. This is the major institutional investors who are doing so. The aim for an average trader is to find a Supply & Demand Market Zone where there is high liquidity, where trades can be placed with negligible price impact.

Supply and Demand Zones:

Identifying supply and demand zones is the basis for the trade-in supply and demand. As markets experience dramatic rises and falls, orders usually issued by large institutional investors are not filled. They leave pending orders at the base of the liquidity zones to buy or sell, with the hope that the market will return to fill the remaining orders. The demand zone is a high price increase zone and the supply zone is the one where the economy has made a sharp decline.

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