Few people pay much attention to market liquidity, yet it is a major cause for market collapse. Commentators on the nightly news will tell you that markets are declining for whatever easily digestible reason, but the truth of the matter is that any sudden market collapse is precipitated by leverage, the ability to meet debt obligations and, ultimately, on the availability of both market and funding liquidity.
The chart below illustrates the wide range of policy tools that America’s central bank – the Federal Reserve – has implemented as a response to the current crisis in order to stabilize various parts of financial markets and the economy by providing liquidity.
As you can see, the complexity of the Federal Reserve’s response can be highly confusing. However, understanding how the Central Bank responds to financial and economic stresses will help you understand where money (and credit) are flowing; this flow of capital influences inflationary or deflationary forces which can collapse or increase asset prices. If you can understand this, you are ahead of other traders and investors who are looking for signs of recovery before taking a position.
That said, these monetary factors are only a part of the broader macro environment which impacts asset prices. Indeed, there are various factors that play a role in moving markets – these elements can be mapped, analysed and understood so that informed decisions can be made about appropriate positioning.
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