Do You Truly Understand Liquidity Risk? by Sam Eder

As the saying goes, “liquidity is always there until you need it most”.

Liquidity disappearing is what happened in the 2008 financial crisis – things just shut down and people stopped trading with each other. It took the Federal Reserve to step in and provide liquidity to the markets to avoid a global financial meltdown.

The SNB removal of the currency peg was a liquidity event. The reason prices fell so far is that no one was willing to step in and be a buyer until extreme levels. Also, it’s important to note, the market makers who were filling orders at prices the inter-bank market was not trading at became voluntarily liquidity providers.

The reason I am bringing this up?

The inter-bank market, as Sean Lee identified here, is drying up as banks close down their prop trading desks. In an event-driven market like we are in currently in, this is of particular concern.

You can see the cracks forming, and a lot of tail risk events seem much more probable than they have done in the past. Don’t underestimate Greece, and the risk to the Euro. Or Russia for that matter. Putin is much smarter and more ruthless (and has a much larger base of home support) than the western media give him credit for.

But the most dangerous event is the one we don’t know about yet.

If you are trading leveraged positions, consider carefully your liquidity risk, and put whatever protection you need to in place. Like the aphorism said at the start – it will be too late afterwards.

A special note to euro traders. Tail risks are very high at the moment. Something that only has a 1-2% chance of happening can still happen, so please be wary. There is some dangerous brinksmanship going on with some very inexperienced players.



About the Author

Sam Eder is a currency trader and author of the Definitive Guide to Developing a Winning Forex Trading System and the Advanced Forex Course for Smart Traders. He is a part owner of Forex Signal Provider (You can get a free trial). If you like Sam’s writing you can subscribe to his newsletter for free.

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