What number of shares determines adequate liquidity for a stock?

By Investopedia Staff AAA
A:

Liquidity refers to how easy it is to buy and sell shares without seeing a change in price. If, for example, you bought stock ABC at $10 and sold it immediately at $10, then the market for that particular stock would be perfectly liquid. If instead you were unable to sell it at all, the market would be perfectly illiquid. Both of these situations rarely occur, so we generally find the market for a particular stock somewhere in between these two extremes.

The bid-ask spread and volume of a particular stock are closely interlinked and play a significant role in the liquidity. The bid is the highest price investors are willing to pay for a stock, while the ask is the lowest price at which investors are willing to sell a stock. Because these two prices must meet in order for a transaction to occur, consistently large bid-ask spreads imply a low volume for the stock while consistently small bid-ask spreads imply high volume.

For example, a bid of $10 and an ask of $11 for stock ABC is a fairly large spread, meaning the buyer and seller are far apart. No transactions can take place until the buyer and seller agree on price. Should this large bid-ask spread continue, few transactions would occur and volume levels would be low, implying poor liquidity: either the bid or ask price (or both) would have to move for a transaction to take place. On the other hand, a bid of $10 and an ask of $10.05 for stock ABC would imply that the buyer and seller are very close to agreeing on a price. As a result, the transaction is likely to occur sooner and, if these prices continued, the liquidity for stock ABC would be high.

However, liquidity is more of a qualitative measure, meaning there is no one quantity of stock volume that can tell us how liquid an investment is.

(For more on the bid-ask spread, read our article Why the Bid/Ask Spread Is So Important.)

RELATED FAQS

  1. Where can I find out about upcoming stock splits?

    Learn what a stock split is, how it is accounted for and where to find upcoming information about stock splits on the Internet.
  2. Does the buyer or the seller control a call option?

    Buy call options and maintain control over the price you pay and when to buy a given stock. Learn how to maintain control ...
  3. How do I invest or trade market indicators?

    Read about how investors can trade actual market indicators, such as the S&P 500 Index, rather than specific stocks or commodities.
  4. What is accounting fraud?

    Learn what accounting fraud is, why a company commits account fraud and some types of accounting fraud that misrepresent ...
RELATED TERMS
  1. Catastrophe Equity Put (CatEPut)

    Catastrophe equity puts are used to ensure that insurance companies ...
  2. Open Trade Equity (OTE)

    Open trade equity (OTE) is the equity in an open futures contract.
  3. Non-Assessable Policy

    A type of insurance policy that cannot require the policyholder ...
  4. Unaffiliated Investments

    Stocks, bonds, and other investment holdings in companies neither ...
  5. Overall Liquidity Ratio

    A measurement of a company’s capacity to pay for its liabilities ...
  6. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...

You May Also Like

Related Articles
  1. Mutual Funds & ETFs

    How do I invest or trade market indicators?

  2. Options & Futures

    Examples Of Exchange-Traded Derivatives

  3. Options & Futures

    Advantages Of Trading Futures Over Stocks

  4. Trading Strategies

    Enter Trades Ahead Of The Emotional ...

  5. Trading Strategies

    Top Day Trading Instruments

Trading Center