What is a liquid market?
A liquid market a market with many buyers and sellers available and relatively low transaction costs. The details of what makes a market liquid may vary depending on the assets traded. In a liquid market, it is easy to execute a transaction quickly and at a desirable price because there are many buyers and sellers and the product traded is standardized and in high demand. In a liquid market despite daily changes in supply and demand, the gap between what the buyer wants to pay and what the sellers will offer remains relatively small. The opposite of a liquid market is called a “thin market” or “illiquid market”. Thin markets can have considerably large differences between the highest available buyer and the lowest available seller.
Key points to remember
- The liquid markets have many buyers and sellers available.
- Liquid market prices change in relatively small increments.
- Financial assets such as certain forex, futures, bonds and equity markets are liquid.
- Markets for trade in specialized physical goods such as luxury goods or homes are illiquid.
Understanding a liquid market
Liquid markets are generally found in financial assets such as forex, futures, bonds and stocks. Markets for tangible, high-priced goods, such as luxury goods, heavy industrial equipment or homes, are considered illiquid markets. But even financial securities can also be traded sparingly depending on a number of factors, including the time of day, the immediate conditions of a given market, or the relative visibility of the asset.
The Fortune 500 company’s stock market would be considered a liquid market, but not the family restaurant market. The largest and most liquid market in the world is the foreign exchange market, where foreign currencies are traded. The daily volume of trade in the currency market is estimated to exceed $ 5 trillion, dominated by the US dollar. The euro, yen, pound, franc and Canadian dollar markets are also very liquid.
The futures markets that trade in major currencies and major stock indices are very liquid, but the futures markets that trade in specialized grains or metal products can be much less traded.
Benefits of a liquid market
The main advantage of a liquid market is that investments can be easily transferred in cash at a good rate and in a timely manner. For example, if someone owns $ 100,000 in US treasury bills and loses their job, the money in these treasury bills is readily available, and the value is known because it is a liquid market. However, on the other hand, real estate is not as liquid. Since there may be a small number of buyers for a given home within a given time frame, it may take longer to sell the property. The more you need to sell it quickly, the lower the offer you will have to make to sell, which means that you will receive less money for it.
Liquidity and volatility
An important factor related to liquidity is volatility. Low liquidity, a poorly traded market, can generate high volatility when supply or demand changes rapidly; conversely, high and sustained volatility could distance certain investors from a particular market. Whether it is correlation or causation, a less liquid market is likely to become more volatile. With less interest, any price change is exasperated because participants have to cross wider spreads, which in turn further displaces prices. Good examples are the markets for commodities that are poorly traded such as grains, corn and wheat futures.