Understanding market liquidity

If you are going to be successful at investing, you have to understand market liquidity, what it means, why it matters, and how you can predict the liquidity of a market. Market liquidity will impact how successful your trades are, and how well your investment risks pay off.

What is liquidity?
The first thing you have to understand is what liquidity is. Liquidity refers to the level of market interest available at any given moment for a particular asset or security. In other words, how well is the particular asset selling. What is the level of market interest? Meaning, what are the level of buying and selling volume? The markets can have high liquidity, or great liquity, or they can be a thin market, and be what is called illiquid.

What are the conditions that lead to great liquidity?
Great liquidity or higher liquidity usually means a deeper market. The best markets are those without specific hours, and that have a lot of volume. High liquidity makes it faster and easier to buy or sell a security.The forex market is typically a higher liquidity market than a stock market simply because of the volume of it.

What are the conditions that lead to illiquidity?

Illiquidity is when it is harder to buy or sell an asset. Illiquidity is when it is a thin market, and prices move more rapidly on relatively lower trading volumes. A market that only trades during certain hours is less liquid, or a thinner market. A good example of a market that tends to be illiquid is future contracts.

Why liquidity matters?
When you invest, liquidity matters a great deal. It determines how quickly prices move between trades over time. It affects your trading strategies, and how profitable you can be. Illiquidity can be very damaging to an investor, making it difficult to buy or sell an asset, and resulting in rapid price movements, lost opportunities, etc. A higher liquid market is easier to learn in, and makes up for some mistakes. Thus, if you are new to investing, or learning, it is best to practice in markets with high liquidity.

High liquid markets (Like the forex market), see large trading volumes transacted with relatively minor price changes. A large exchange or trade on the stock market could cause prices to fluctuate greatly, whereas in a higher liquidity market like the forex market, it may barely be a blip on the radar.

Regardless of the market you trade in, the liquidity can fluctuate during the day, with higher trading volumes, and better liquidity in the mornings when a market opens, and lower volumes near the close of the market. Understanding liquidity, what it means to your investments, and how it is influenced can make you a more savvy investor, and a more calculated risk taker. Thus increasing your chances for investment success.