Thin Market

What Is a Thin Market?

A thin market on any financial exchange is a period of time that is characterized by a low number of buyers and sellers, whether it's for a single stock, a whole sector, or the entire market. A thin market, also known as a narrow market, can lead to price volatility.

Key Takeaways

  • A thin market has few active participants on the buy-side or the sell-side.
  • Price movements in thin markets tend to be larger than normal.
  • A thin market is the opposite of a liquid market, which has enough participants to keep a balance between buyers and sellers.

Understanding Thin Markets

A thin market has high price volatility and low liquidity. The balance between supply and demand can tip abruptly, creating a substantial impact on prices. Since few bids and asks are being quoted, potential buyers and sellers may even find it difficult to make a transaction.

Although the overall volume is low, individual transactions tend to be large. That means price movements are greater. In addition, the spreads between the bid and ask prices for an asset tend to be wider, as traders attempt to profit from the low number of market participants.

A thin market is the opposite of a liquid market, which is characterized by a high number of buyers and sellers, strong liquidity, and relatively low price volatility.

Liquidity, by definition, is a measure of the ease and speed at which an asset can be converted into cash at a fair approximation of its value. Cash in the bank is a liquid asset. A house or an Old Master painting is not.

Generally speaking, stock shares might be considered liquid assets. They can be sold easily at any time and the cash will be available with only a short delay. They should have a value equal to or greater than their original cost unless the seller picked a loser.

However, a thin market by its nature damages liquidity. Individual investors may find it difficult or impossible to get a fair price in a thin market.

The most predictable thin market on Wall Street occurs every year in the last half of August when most traders abandon their desks and go to the beach.

Individual investors are wise to get out of the way of a thin market.

Effects on Trading

When transaction-level data first became available in the early 1990s, the impact of institutional investors on thin market prices, and on market prices in general, became clear for the first time. Transactions by a few large institutions account for more than 70% of the daily trading volume on the New York Stock Exchange (NYSE).

That means they have to take the size of their own orders into account in their trading strategies. Large traders break up their orders into smaller blocks, which are then placed in a series of transactions staggered over time.

More than half of the trades placed by large institutions now take at least four days to complete. If they pushed through all the trades at once, the prices they paid to buy stocks or received to sell stocks would be adversely affected by their own trades.

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