The scale of the forex market means that the amount of buying and selling volume happening at any given time is extremely large! This makes market liquidity, which is the ability to buy or sell a large quantity of something with minimal price impact, very HIGH
Forex is considered the most liquid market in the world due to the high volume and frequency with which it’s traded. So in the forex market, liquidity pertains to a currency pair’s ability to be bought and sold without causing a significant change in its exchange rate.
In an OTC market, participants can be picky and determine who they want to trade with depending on trading conditions, the attractiveness of prices, and the reputation of the trading counterparty (the other party who takes the opposite side of your trade).
The chart below shows the seven most actively traded currencies.
- The U.S. dollar is the most traded currency, making up 84.9% of all transactions!
- The euro’s share is second at 39.1%, while that of the yen is third at 19.0%.
- As you can see, most of the major currencies are hogging the top spots on this list!
The Dollar is King in the Forex Market
You’ve probably noticed how often we keep mentioning the U.S. dollar (USD).If the USD is one-half of every major currency pair, and the majors comprise 75% of all trades, then it’s a must to pay attention to the U.S. dollar. The USD is king!
In fact, according to the International Monetary Fund (IMF), the U.S. dollar comprises roughly 62% of the world’s official foreign exchange reserves!
Foreign exchange reserves are assets held on reserve by a central bank in foreign currencies.
Because almost every investor, business, and central bank own it, they pay attention to the U.S. dollar.
There are also other significant reasons why the U.S. dollar plays a central role in the forex market:
- The United States economy is the LARGEST economy in the world.
- The U.S. dollar is the reserve currency of the world.
- The United States has the largest and most liquid financial markets in the world.
- The United States has a stable political system.
- The United States is the world’s sole military superpower.
- The U.S. dollar represents about half of international loans and bonds. Lots of countries and foreign companies borrow in USD.
- The U.S. dollar is the medium of exchange for many cross-border transactions. For example, oil is priced in U.S. dollars. Also called “petrodollars.” So if Japan wants to buy oil from Saudi Arabia, it can only be bought with the U.S. dollar. If Japan doesn’t have any dollars, it has to sell its yen first and buy U.S. dollars.