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Liquidity

Liquidity is the ease with which an asset can be bought or sold quickly without significantly affecting its price. In a liquid market there are always enough buyers and sellers, the bid-ask spread is narrow and large orders do not move the price much.
Contents
  1. 1.Key points
  2. 2.Formula / calculation
  3. 3.Interpretation
  4. 4.Pitfalls
  5. 5.Frequently asked questions

Key points

  • For stocks, liquidity relates to trading volume, free float and market cap; for funds, to settlement time and portfolio holdings.
  • High liquidity makes entering and exiting positions cheap and fast; institutions prefer liquid stocks.
  • an asset that looks liquid in normal times can lose liquidity in a panic.

Formula / calculation

average daily TL volume, volume / market cap (turnover), the bid-ask spread and order book depth are indicators of liquidity. On a company balance sheet liquidity is measured by the current and quick ratios.

Interpretation

High liquidity makes entering and exiting positions cheap and fast; institutions prefer liquid stocks. Illiquid assets may be impossible to sell in a crisis or sell only at a deep discount; this is liquidity risk.

Pitfalls

an asset that looks liquid in normal times can lose liquidity in a panic. In illiquid stocks price manipulation is possible with small volumes. A fund’s liquidity and the liquidity of its holdings can differ.

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Frequently asked questions

Liquidity is the ease with which an asset can be bought or sold quickly without significantly affecting its price.

average daily TL volume, volume / market cap (turnover), the bid-ask spread and order book depth are indicators of liquidity. On a company balance sheet liquidity is measured by the current and quick ratios.

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