Liquidity – Market Liquidity

In terms of economics, finance, and investing, liquidity may refer to a few things.  Basically, however, it is nothing more than a measurement of the degree to which buying a security is possible without affecting its value.  Higher levels of liquidity likely lead more frequent trading, for example.  Unlike other financial terms and principles, in this case there’s no set formula that determines the actual value.  Several different formulas can be applied and could create an accurate look at it, but these will vary depending upon a wide range of different factors.  It may also refer to the ease with which an asset can be turned into cash.

Cold, hard cash is the most liquid asset available since it can be traded and exchanged on an almost constant basis without affecting its value – other factors may change its overall valuation, but the amount of money exchanged won’t usually be a factor.  Assets with high liquidity are usually very simple to sell quickly, and buying or selling them wont’ really have an impact on their overall value.  An illiquid asset, on the other hand, is usually not as saleable and will often be more difficult to unload.  There are a few good examples of both of these types of assets.

Illiquid assets include very large amounts of stock.  Since liquidity is a measurement of being able to sell without changing value, and since selling very large amounts of stock could change the value of said stock, this example is highly illiquid.  On the other hand, most small amounts of stock in nearly all companies carry a good deal of liquidity with them since they can be sold without affecting the value in any discernible way.  The biggest influencers on these formulas are often market makers themselves or speculators, although a wide range of other variables could influence it.

Obviously, your long and short term trading goals will be greatly affected by market liquidity.  That’s why it is so important to factor this attribute into any trade.  Plenty of different ratios exist that can be applied to your stocks to help you get a better idea of liquidity and to figure out just what the right decision to make is.  It’s always important to understand everything that you can about your investments, and this is certainly one of the best examples.  It isn’t hard to understand, but it could have a profound impact on your future trades.

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