DEFINITION of Sold-Out Market
A sold-out market is a scenario wherein all, or nearly all, of the remaining investors have sold or closed out their positions. Sold-out markets, as a result, contain very few traders left to sell anything, hence, the name. A sold-out market can occur for various reasons, such as limited choices and/or poor liquidity - although a market becoming sold-out has further negative effects on liquidity.
BREAKING DOWN Sold-Out Market
A sold-out market is a relatively uncommon condition in modern listed exchange that occurs when most of a contract's long positions have already been sold or liquidated, and therefore produces an increasingly short supply. It is uncommon on modern exchanges because these institutions generally make use of a market maker or specialist mechanism, or else have an abundance of eager liquidity providers who will provide an offer to any buyer in the market. This lack of activity therefore most observed in over the counter (OTC) markets from time to time, where buyers sometimes struggle to find sellers and vice versa. Because over the counter markets do not have the liquidity mechanisms such as those found on regulated exchanges, there may not always be an eager or available seller of a particular asset.
Generally, sold-out markets occur in the forward markets or in assets based on industries that have limited liquidity to begin with. In the worst case, once a market is sold-out, no more contracts are available for sale and trading grinds to a halt.
When a sold-out market occurs in a currency pair after a downward movement, it tends to indicate that the forex rate for that currency pair may soon correct and should rise.
Example of a Sold-out Market
Say that a yogurt producer hedges their price risk using forward contracts, and that supermarket chains often take the other side of these contracts to hedge changes in consumer demand for yogurt products in their stores. The yogurt forward market trades over the counter. Recently, there have been several new entrants in terms of new yogurt producers who also seek to hedge their risk exposure. However, the supermarket chains have already hedged all of their risk and are unwilling to sell any more forward contracts, which would actually increase their own risk exposures since they are already fully hedged. As a result, these new yogurt producers confront a sold-out market in yogurt forwards and are unable to hedge.
In economics terms, this may be construed as a market failure since demand for some asset exceeds its supply with no apparent resolution.