Bites of trading knowledge #3

What is liquidity and what is its significance? 

Liquidity refers to the availability of a product and ensures market participants have the ability to buy and sell easily.

A liquid market increases the likelihood for finding a counterparty when entering or exiting a trade.

What is volume a measurement of in trading? 

Volume in trading refers to the total number of contracts exchanged between buyers and sellers of a market during trading hours over a given period.

Higher trading volumes are considered more positive than lower trading volumes because they indicate the availability of orders in the market allowing better order execution during the trading session.

What is open interest in the derivatives market? 

Open interest is the total number of outstanding derivative contracts, such as options or futures that have not been settled for an asset.

Open interest equals the total number of bought or sold contracts, not the total of both added together. Increasing open interest represents new or additional money coming into the market while decreasing open interest indicates money flowing out of the market.

Risks and opportunities for corporates and individual investors – Position and risk management 

Risk management is the responsibility of market participants designed to limit risk exposures that specifically applies to the participants financial profile in the market.

The financial profile of a participant may include their role in the financial market or the amount of capital under their responsibility to be managed in the market, and therefore the risk variables that each would need to identify may be unique.

For both corporate and individual investors, the market to trade would be a key variable to clearly state and support with reasons for trading or investing. Reasons for selecting one market over another could include price volatility, liquidity, daily volume traded, size of the minimum price increment, and value of the minimum price increment. Comparing these variables between markets will help decide the suitability and/or risk of each.

For example, if bitcoin (BTC) moves around 1,000 points per day and each point is worth $1, a trader might experience a $1,000 fluctuation in their account balance for one day. Another example is the U.S Dollar / Singapore Dollar (USDSGD), which could move 70 pips or more per day and trading a standard lot size with each pip worth $10, a $700 fluctuation could be expected for one day.

Market participants may also manage their risk through the size of their positions. The larger their position size, the greater is their exposure and the smaller their position size their exposure is lower. Investors should determine the risk that would result from various position sizes and select the size that ensures that their risk limit is not exceeded.

Finally, setting stops with a specified loss amount provides protection if the market does not move in the desired direction. It helps to prevent creating a loss scenario which is larger than an account can handle.