Liquidity
Family VII · Market & styles
Not to be confused with liquidity sweep, liquidity provider forex, liquidity provider.
Liquidity describes how readily a market absorbs buy and sell orders at or near the prevailing price. It is not a fixed property of an asset but a condition that varies by venue, time of day, and order flow. High liquidity means many resting orders and small price concessions; low liquidity means the opposite.[1]
What liquidity looks like
Liquidity is visible in the order book. A deep book has multiple price levels with size on both sides, so a market order of moderate size fills near the best bid or offer. A thin book has few levels and small size, so the same order walks the book and moves the price.
Two common measures are the bid-ask spread and market depth. A tight spread and large depth indicate high liquidity; a wide spread and shallow depth indicate low liquidity. Liquidity also varies intraday, often peaking when major financial centres overlap and falling during holidays or news events.
Worked example: cost of a market order
Suppose a stock has a best bid of 100.00 and a best offer of 100.02, giving a spread of 0.02. An investor buys 1,000 shares at the offer and later sells them at the bid, with no price change in between.
The 20 is the direct cost of crossing the spread twice. If the spread were 0.10 instead, the same round trip would cost 100. Liquidity, as reflected in the spread, determines that cost.
Liquidity is not constant
Liquidity can evaporate quickly. During scheduled data releases, unscheduled news, or market stress, participants may withdraw quotes, widening spreads and reducing depth. An asset that is liquid under normal conditions can become illiquid precisely when traders most want to trade. For this reason, liquidity is often described as a fair-weather property.
Often confused with
- liquidity sweep
- A liquidity sweep is a trading event in which price moves to trigger resting orders around a level, whereas liquidity itself is the general capacity to trade without price impact; the sweep is an action, liquidity is a condition.
- liquidity provider forex
- A liquidity provider forex is a firm that streams bid and offer prices in the foreign exchange market, whereas liquidity is the market quality those quotes help create; the provider is a participant, liquidity is the attribute.
- liquidity provider
- A liquidity provider is an entity that continuously quotes buy and sell prices to supply tradable depth, whereas liquidity is the resulting ease of transacting; the provider is the source, liquidity is the outcome.
See also
References
- ↑ Trading hours published by the exchanges and venues concerned. Session boundaries shift with daylight saving in each region and are not the same all year.