In trading, what does liquidity mean and how does it work


In trading, what does liquidity mean and how does it work

In: Economics

Liquidity its cash availability. If you have all of your money tied up in investments you’re not very liquid. You would need to liquidate some of your assets if you wanted to have enough cash to purchase another asset.

To put it simply, liquidity is the amount of supply and demand for a product. For instance, it is very easy to purchase Bank Of America stock because there is a lot of it, and people are constantly buying and selling it, and offering bids and offers. This means that there is a lot of liquidity for this stock. When a stock is liquid, you can almost literally buy or sell it at anytime, without impacting the price very much if at all.

You can think of it as the ‘transferability’ of a financial instrument (either cash, or an investment). High liquidity means it’s easier to use and transfer an item; low liquidity means you’re pretty much stuck with it.

Cash is a very liquid thing. You don’t need to find a buyer before you can use it, or involve a middle man. You can just go out and spend it. If all of your wealth is tied up in housing, for example, that’s not very liquid. If you can’t find a buyer, you’re technically *worth* a lot, but if a hot new investment opportunity opens up, you’re probably not going to be able to get enough cash together quickly to invest in it.

Similarly, if there’s an investment that is constantly changing hands — Bank of America stock, as /u/Bhimpele said — then it’s considered liquid; it moves around the marketplace a lot. If you have a stock that very few people are interested in buying or selling (and it can be either, not both), it’s not liquid. It’s either very hard to take possession of it, or if you’ve got it it’s a pain in the ass to get rid of — therefore it’s not easily transferable.

It’s liquid because it flows easily from one place to another.

It’s how fast you can turn something to cash. High liquidity means you can sell it quickly and get your cash back. Low liquidity is more like a house. If you need the money today, it ain’t gonna happen.

Edited to add that if something is not very liquid (like a house) the only way to sell it quicker is to sell it at a discount. Hence price can have an affect on liquidity. Stores do this with items that aren’t selling well when they would rather have the cash again.

Liquidity means easy to convert into another asset. Cash in a checking account is super liquid, because you can turn it into anything. Stock of a major company is pretty liquid because you can sell it instantly during market hours. Shares of a private company are less liquid because there is a process of when and how you might be able to sell. Real estate is also less liquid because it takes times to list, sell, close, etc.

Cash is a liquid asset: everybody takes it, its constantly changing hands, and therefore there’s an agreed upon value because everybody can ask for pretty much the same things for it.

A house is *not* a liquid asset: If you want to sell a house you have to go through a lot of effort, pay a bunch of fees, and wait a long time for somebody to come along who wants to pay as much as you’d like. If you wanted to sell your house quickly because you desperately needed the money, you’d have to price it really cheap to attract a buyer quickly, but you’d lose a lot of the potential value.