Liquidity is definitely an important concept within the market that is financial. It has two main connotations in a macroeconomic µeconomic sense. In macro, liquidity is defined as the overall flow of money, which is influenced by central bank.
On the other hand, in microeconomics, liquidity refers to the available supply of an* that is asset( in a few period.
For example, in forex currency trading, pairs such as the EUR/USD &GBP/USD are popular, meaning them easily that you can buy &sell. There will always be counterparties for these securities.
On the other hand, some currency pairs called exotic like TRY/BRL (Turkish lira vs Brazilian real) or SGD/TRY ( Singapore dollar vs lira) are often thinly traded. Most brokers that provide these pairs see only handful of activity on given day.
The same situation happens in the stock market, where some shares like Apple &Microsoft are actively traded compared with other small rims that are unknown Expion360 & Taken Art.
what exactly is liquidity?
As stated earlier, liquidity relates to the volume that is overall of asset that is available in the market. It is an measure that is important of its vital impact among traders. Along with stocks &forex liquidity can also be an part that is important of assets, like cryptocurrencies &bonds.
In crypto, it is estimated that there are over 21,000 currencies that are digital the entire world today. In these, the absolute most ones that are popular Bitcoin, Ethereum &Ripple.
For these ones, it is relatively easy to trade since there will always be counterparties. On the other hand, there are some coins &tokens that are thinly traded.
How liquidity affects markets
Liquidity has an important role in the market for three main reasons. First, trading low-liquidity assets is usually more* that is expensive( compared to the others. This* that is( is more popular in the forex industry, where brokers don’t charge commission but make money using the bid-ask spread.
For highly-liquid pairs like the EUR/USD &GBP/USD, the cost of transactions is usually negligible. On the other hand, for illiquid pairs like SGD/TRY, the overall cost of transactions is usually relatively high. For American stocks, brokers like Schwab &Robinhood don’t fee for transactions.
Liquidity also affects the overall time of trade execution. For high-volume assets, trades are executed at lightning speed since there is always counterparty in the other side. On the other hand, for low-volume assets, there is lag that is usually small that could affect profitability.
Related » Understanding stock volume
Further, liquidity could have a role in market manipulation. Generally in most periods, it really is so hard to control stocks like Apple &Microsoft that have daily number of vast amounts of dollars.
It is easy to control companies that are thinly-traded*) worth few millions of dollars. Some brokers may cancel some trades because of low liquidity.
Finally in some cases liquidity affects the volatility of a asset. Some thinly traded assets could have few but market that is large.
How to determine whether stock is liquid or not
So, how do you determine whether stock or any other asset is liquid or not? There are three main ways of determining whether stock is liquid or not.
First, There is the true name recognition of company
For highly companies that are popular Apple, Meta Platforms &Alphabet, liquidity is never problem.
However, if you identify small company that is not well-known, chances are that its liquidity will be lower. always The the next thing to test is really a company’s relative volume
that will be usually supplied by most companies, including brokerages like Robinhood & Schwab. A stock with little relative volume ensures that this has low liquidity
in the long run. It really is relatively simple to determine an asset’s volume within the market that is financial Finally, there is the bid-ask spread of an asset. In stocks, you will likely not see these spreads
But they are popular in forex. That they have low liquidity. Pros of trading low-liquid assets
There are numerous benefits of trading low-liquid assets if you see currency pair with thin spreads, it is sign. First, these assets might be hidden gems since most traders don’t follow them. In accordance with Peter Lynch, it is usually possible to help make large amount of money in assets that many people avoid. Second, there clearly was usually no or competition that is limited*) in the market. As result, you can use your experience &expertise to find opportunities in such assets. Finally, you can use these assets’ volatility to
gain an edge in the market.
How to get trading that is & Develop Ways to trade low-liquid stocks There are several methods of use when trading low-liquid stocks. First,
always research your facts in the asset just before execute trade. This research could include fundamental or analysis that is technical Second, you should
always set stop-loss* that are & take-profit( when trading these assets due to the volatility risk. Finally, always trade them
when it has an market-moving that is important
like earnings or economic data.
Risks of low liquidity
- As mentioned above, there are several risks for trading low-liquid stocks &other assets. These risks include: Expensive to trade( trader that is*)As it is usually crucial that you focus on transaction costs
Unlike investors, you likely implement tens of trades a day. And therefore, the cost that is overall of can be high. Therefore, trading low assets that are liquid to be costly in many cases because associated with the wider spreads
- Pump &dump schemes Thinly-traded stocks &cryptocurrencies are ripe for pump-and-dump schemes
- This is really because traders with limited amount of cash might have role that is major stocks.
- For example, trader with a $ account that is 100k easily move stock of company with market cap of approximately $1 million. Similarly, trader and group of traders can manipulate small crypto
Having said that, it really is relatively hard to manipulate stocks like Microsoft & Google. Analysis challenge
exit point sit is definitely difficult to* that are analyze( low-liquid assets like stocks &cryptocurrencies. These assets tend to have no major catalysts & news. Also, in technical analysis, it is almost impossible to incorporate volume into it.
Finally in most cases you will find
limited exit points particularly when the low-liquid asset can also be range-bound. It is hard to trade such assets that are financial Summary
Low-liquid assets are in most cases
more than high-liquid ones(). In this article, we have explained what liquidity is &how it works in the market. We have also looked at how to trade liquid that is low &other assets.()External useful resources(*)
- What are low liquidity assets?
- What happens when liquidity is low?
- How do you solve liquidity problems?
- How do you maintain liquid assets?
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