What Is Depth Of Market And Why Is It Important For Your FX Trades?
Forex trading is one way of deploying your investible resources. An inexperienced trader can find it difficult to understand how the market functions.
However, by using the tools that are available to you, it is quite possible to come to grips with the market and start making profitable trades.
There are several techniques that you can use to help you to decide about the direction that the market is likely to take.
One key tool that can help your trading activity is the intelligent use of depth of market data.
What exactly is depth of market and how can you use it? In forex trading, depth of market refers to the liquidity available to efficiently getting the investors’ orders done with minimum slippage.
Depth of market data provide you with information liquidity at different prices. An observant investor would be able to decipher the sentiment of the makers, who are largely made up of banks and institutions.
If used correctly, this wealth of intelligence can give you a tremendous advantage. It can help to take the guesswork out of a trade and allow you to take a position based on the real-time information present before you on your computer screen.
Consequently, you will be able to trade with a greater degree of confidence and increase your chances of entering into winning trades.
Why it’s important
The first step that you have to take is to ascertain if your broker offers depth of market. Access to this information will provide you with an insight into volume and liquidity data.
You will be able to get a feel of the market sentiment. This knowledge can be invaluable when placing a trade.
Let’s see how you can actually make use of depth of market. Consider a situation where the data reveals that the bid side liquidity exceeds offer side liquidity. This could indicate a bullish trend for the currency pair.
Conversely, if offer side liquidity exceed bid side liquidity, it could be a bearish indicator. Of course, depth of market should not be used in isolation. You can combine this data with other technical analysis charting tools to make a prediction about the direction that the market will take.
Remember that if you are a short-term trader, liquidity information can be crucial to your success. Depth of market, which provides details about the constant shift in liquidity, provides you with information that you can put to immediate use.
How to use depth of market data
One category of forex traders who use depth of market extensively are those who practice scalping. This refers to entering into a series of trades, each of which has the potential to give you a small profit.
This technique of skimming the market involves holding positions for a very short period of time. You can enter and exit the market several times a day and pocket small gains each time. If you use this technique, you don’t carry a trade over to the next day.
Scalping makes extensive use of depth of market information. That’s because technical indicators and candlestick charts don’t work very well in extremely short time frames.
Depth of market provides information about the direction that the market could take. This data and the order flow can give scalpers a very good idea about the short-term market for the currency pair that they are proposing to trade.
A scalper is usually satisfied with a profit of five or ten pips on a particular trade. Although this is a relatively small amount, it can add up to a substantial sum if the process is repeated successfully several times.
Again, depth of market should not be used in isolation. You need to combine it with other tools to make an accurate judgement of the direction that the market will take in the very short term.
A word of caution is warranted here. Scalping is not for everyone. It requires a high degree of concentration and the willingness to remain glued to your trading desk looking out for the smallest profit opportunity.
You also need to have the ability to process various pieces of information in real time and to make quick trading decisions based on the conclusion that you reach.
Depth of market data is not only for scalpers
What if you are not cut out to be a scalper? The prospect of looking closely at your computer screen continuously for hours on end does not appeal to you. Can you still make use of depth of market?
In fact, forex traders who take large positions also use depth of market data extensively. This information plays a crucial role as it allows them to see the liquidity at each price level.
What if you don’t fall into either category? You are not a scalper and neither a large trader. While it is true that depth of market will not be a crucial input for you, it will still play a role in helping you to get a feel of the market.
Dickson Woon, Senior Manager in FX Business Development at Phillip Futures believes that investors with different ticket sizes will be able to have higher chance of getting the orders fulfilled with an increase of market depth. “This is especially crucial in fast moving markets because very often, the thin liquidity causes non-fulfilment of orders in critical entry or exit levels.”
Don’t ignore this key source of intelligence. It can help you to make the right trade if you are not sure about the direction that the currency pair that you are trading will take.
Trade with a broker who offers a guaranteed market depth
The depth of market data that you see on your screen does not represent 100% of the trading volume. That’s because the forex market is decentralized. As such, market depth determination for the forex market is very different from that in the stock market.
Unlike investors in the stock market, Woon explains that investors who participate in the forex market will have to understand the exchange-traded model versus the OTC (over the counter) model.
“In the exchange, liquidity is determined by the number and profile of participants who would assume the role of both ‘maker’ and ‘taker’ and match orders among themselves. Most exchanges operate in the Central Limit Order Book and investors will be able to see their own orders, as well as the liquidity depth of the market,” explains Woon.
“However, in the OTC market, fair value prices and liquidity are made by banks and larger institutions (‘maker’). Investors will only assume the unilateral role of ‘taker’ of price in this case. The unique nature of OTC means that the quality and commitment of makers to constantly provide good prices and liquidity is critical to investors.”
Due to this reason, it’s important to find a good intermediary between the investors and the market maker i.e. a broker, which can provide you with extensive details about depth of market.
Phillip Futures would be one such option. As one of Asia’s top brokerages for trading foreign exchange, it acts as an intermediary between the investors and market makers. Phillip Futures is assuming the role to negotiate for liquidity requirement and customization from banks and institutions based on different needs of investors.
Right now, Phillip Futures is offering its clients a unique proposition. It “guarantees” a market depth of 5 million. What this means is that at any point in time, you will have access to a large volume of data that can indicate the supply and demand position for a currency pair as well as its liquidity.