What is a Liquid Market
A liquid market is a market with many bids and offers, low spreads, and low volatility. In a liquid market, it is easy to execute a trade quickly and at a desirable price because there are numerous buyers and sellers. In a liquid market, changes in supply and demand have a relatively small impact on price. The opposite of a liquid market is called a "thin market" or an "illiquid market."
BREAKING DOWN Liquid Market
The market for the stock of a Fortune 500 company would be considered a liquid market, but the market for a family-owned restaurant would not. The largest and most liquid market in the world is the forex market, where foreign currencies are traded. It is estimated that the daily trading volume in the currency market is over $5 trillion, which is dominated by the U.S. dollar. The markets for the euro, yen, pound, franc and Canadian dollar are also highly liquid.
Advantages Of A Liquid Market
The main advantage of a liquid market is that investments can be easily transferred into cash at a good rate and in a timely fashion. For example, if someone owns $100,000 in U.S. Treasury bills and loses their job, the money in these Treasuries is easily accessible, and the value is known because it is a liquid market. However, on the other hand, a property is not so liquid. Because there is a finite number of buyers for a house it will take longer to sell the property, and the faster you need to sell it, the less money you will receive for it.
Liquidity and Volatility
One significant factor that affects liquidity is volatility. Whether its correlation or causation, a market that has less liquidity is likely to be more volatile. With less interest, any shift in prices is exasperated as participants have to cross wider spreads, which in turn shifts prices further. Good examples are lightly traded commodity markets such as grains, corn, and wheat futures.