What is liquidity?
The most liquid of all assets is cash, since it can be easily converted without changing its asset value and doesn’t need to be traded with anything to retain its value.
Other assets, such as our homes, cars and art collectibles, are considered illiquid – they are less quick to convert as these types of assets can sit in the market for quite some time before being sold. More importantly, they may eventually be sold at a depreciated price or a price that doesn’t reflect its inherent value, especially if a homeowner, for example, needs to sell their home off quickly.
KEY TAKEAWAYS
- Liquidity refers to how quickly an asset can be bought and sold for its inherent value without affecting its market price
- Cash is considered the most liquid asset, whilst homes, cars and art collectibles are deemed illiquid
- Liquid stocks are mainly associated with large cap stocks
- How liquid or illiquid a stock is, is associated with their level of risk
What is liquidity in stocks?
Liquidity in stocks, in a nutshell, refers to the level of supply and demand associated with particular stocks. This means that a liquid stock is one that can be traded quickly and easily without a major impact on the price, because there are enough buyers and sellers to make that transaction as smooth as possible. Liquid stocks are mainly associated with large cap stocks – your Tesla’s and Apples for example – as there are large numbers of them floating around the stock market being traded throughout the day.
Stocks can be both liquid and illiquid and where they fall on the spectrum is associated with their level of risk. So, if a stock is low in risk, it’s likely to retain its value when it’s traded, meaning it can quickly find a new buyer on the other side. However, if a stock is associated with high risk, it is more difficult to sell quickly and at the same price it was bought for. These types of stocks are more suitable for experienced investors who are prepared to lose all of the money invested.
Which investment has the least liquidity?
Houses, property and land are considered the most non-liquid assets, on the basis that they can take days, months (sometimes even years) to close a sale from start to finish. That’s because the process requires an investor, negotiations, lawyers and a closing price – these all take time! If you want to liquidate them, that often means compromising on the price.
Example of Liquidity
Let’s use a big-cap company like Apple and Amazon as an example. With millions of shares floating around the stock market, they are highly liquid assets which attract a lot of investor attention. That means they can be snapped up quickly. This is compared to other companies which may be considered ‘less liquid’ which don’t have a volume of millions being traded daily and a high demand.