Liquidity

Liquidity is the extent to which a security is easily tradeable.

If a security is constantly trading in large quantities it is liquid. A liquid security can be sold easily and quickly, so investors have the assurance that if they wish to sell a holding they will be able to find a buyer at a reasonable price without problems.

Other things being equal, the price of a liquid security is less volatile because, with a constant stream of purchase and sales being offered, each investor has less influence on the price.

Selling an illiquid security is more difficult and the price more volatile. For some securities the effect can be ameliorated by the use of suitable trading systems, for example by requiring market makers to always maintain offers to buy and sell minimum quantities, as is done for mid-cap shares in London.

The problem is more difficult to solve for small cap shares and more obscure securities, not least due to the lack of willing market makers.

The disadvantages of less liquid securities lead investors to demand greater returns on them, this is called the liquidity premium.

Copyright © 2005-2016