If an asset is liquid, it means that you expect to be able to sell it quickly and without taking a significant financial loss. Cash is your most liquid asset, because no selling is required. Bonds, ETFs, company shares, and Treasury Bills are other examples of liquid assets, for which you normally wouldn’t have much trouble finding a buyer.
An original artwork you own is comparatively illiquid, because you’d need to get it valued, find a buyer, and finalize the sale before walking away with your money. Your house is also relatively illiquid, since it could take you a year or two before finding the buyer you want for it. During the 2008 financial crisis, many people were shocked to find that their houses had lost whatever liquidity they once had. Some found it impossible to sell their homes even at a huge loss.
If you hear someone talking about the liquidity of their trading portfolio, a similar meaning is implied. The portfolio in which you invest is liquid if you are able to swiftly convert a large part of it into ready cash, which you might need to do to pay unplanned expenses, for instance.
Although we said equities are considered liquid assets, some are more liquid than others. Stay with us for some more explanation.
Large Market Caps
The shares of companies with larger market capitalization are the most liquid stocks. One reason is that these are the stocks that are actively traded in the greatest volume (in the millions) every day, which means you can rely they will draw consistent interest from buyers. Someone interested in selling shares of Tesla, Apple, Nvidia or Microsoft will benefit from their liquidity in being able to finish off a quick and fair sale.
Another reason some stocks are considered liquid is that the spread between their bid prices (offered by the buyer) and ask prices (accepted by the seller) is normally tight. if someone needed to quickly offload their Nvidia shares, it’s likely they wouldn’t have to take a big loss in doing so. By contrast, the more the bid-ask spread widens, the less liquid is the market for that stock, because the seller might have to stomach a loss in effecting a hasty sale.
Penny Stocks
Looking at penny stocks, which you could pick up for less than $5 a piece, we see that their daily trading volumes are relatively small, which means fewer people are in the market to buy them. The bid-ask spreads of these shares can tend to be quite wide, and if you wanted to unload 100,000 of them in a hurry, you might run into difficulties. Therefore, penny stocks are viewed as much less liquid than big market cap shares.
Bank Liquidity
An institution like a bank would be called liquid if it held enough of the right kind of assets to fulfil its financial obligations without any problem. If its wealth were held in assets not easily redeemable for cash, the bank would be less liquid.
In the 2008 financial crisis, there were big banks that went under for lack of liquidity. The US Federal Reserve tried to remedy the problem by giving banks injections of capital and liquidity. One key way the Fed generated liquidity was through a process known as quantitative easing, which was the mass purchasing of bank securities like Treasury notes. $4 trillion in liquidity was sunk back into the economy in this way. Boosting liquidity, in this case, was aimed at stimulating general economic growth too.
Wrapping Up
Returning to your trading portfolio, you may find that your need for liquidity comes head-to-head with your desire to see your assets appreciate. This is because, generally speaking, the more liquid an asset is, the less its value will appreciate over time. Keeping suitcases of cash under your bed would be a way of maintaining high liquidity in your assets, but they wouldn’t grow in value. Inflation eats away at the purchasing power of your savings, so they might run out at some point.
Once you agree to give up some liquidity and, for instance, invest your money in the stock market, your funds have a chance of keeping up with the inevitable rise in prices. This is why many people keep a portion of their wealth in very liquid assets in case of need, but the bulk in less liquid ones so it can appreciate.
For CFD traders who trade in the price movements of company shares, the spread between bid and ask prices (and, by extension, the liquidity of the stock in question) does also make a difference. To open a “buy” deal on a stock you believe will appreciate, you must pay the ask price. To open a “sell” deal on a stock you think is about to drop, you will have to pay the bid price. And, as in traditional financial trading, the spread between the two will depend on the volatility (and, ultimately, trading volume) of the stock in question.
