What is Thin Market
A thin market is a market with a low number of buyers and sellers. Since few transactions take place in a thin market, prices are often more volatile and assets are less liquid. The low number of bids and asks will also typically result in a larger spread between the two quotes.
A thin market is also known as a "narrow market."
BREAKING DOWN Thin Market
A thin market has high price volatility and low liquidity. If supply or demand changes abruptly, resulting in more buyers than sellers or vice versa, there will typically be a material impact on prices. Since few bids and asks are quoted, potential buyers and sellers may find it difficult to transact in a thin market.
Though low in volume, transactions tend to be larger. Consequently, price movements in a thin market are inherently more volatile. In addition, the spreads between asset bid and ask prices are wider, as market actors attempt to profit from fewer transactions. A thin market should not be confused with a liquid market, which is characterized by a high volume of buyers and sellers, high liquidity, and relatively lower price volatility.
Trader Impact on Thin Market Prices
A key characteristic of a thin market is the impact traders can have on prices. When the number of buying or selling offers is small, investors' trading positions are large relative to market size. Trading then requires price concessions and thus exerts an impact on prices. The concept of market thinness, while general, is typically used in the context of financial markets.
Market thinness is a particular source of market illiquidity. Liquidity is broadly defined as the ease of trading a security. Apart from market power, lack of liquidity can result from asymmetric information, transaction costs, search and bargaining frictions, imperfect financing ability, limited commitment and spatial considerations.
Since transaction-level data became available in the early 1990s, it has been well understood that institutional investors, whose trade on the New York Stock Exchange (NYSE) accounts for more than 70 per cent of daily trading volume, exert a significant impact on thin market prices and take this into account in their trading strategies.
To counteract the adverse effects of price impact, large traders break up their orders into smaller blocks, which are then placed sequentially. For instance, at the NYSE, only about 20 percent of the total trading value of all institutional purchases and sales is completed within a single trading day, while more than 50 percent takes at least four days for execution. If traded at once, a typical institutional trade can represent more than 60 percent of an asset's total trading volume.