Updated on March 9, 2023
Liquidity refers to the ease with which assets can be converted into cash or may be bought or sold in the market for conversion into cash. Cash is the standard for liquidity as it can be easily used to buy other assets. An important parameter for ascertaining liquidity of an asset is the demand and supply. Market liquidity refers to the ease with which transactions can be conducted for different asset classes. If stocks, securities or other financial assets can be bought and sold easily in a market, it means there are enough buyers and sellers to complete the trade. For instance, if an investor can easily buy or sell stocks of some companies, the stock market liquidity for those assets will be considered as high. However, if there aren’t enough market participants, the market becomes illiquid.
Why is Liquidity important in stock markets?
Liquidity is important since:
1. It determines the ease with which investors can enter or exit from trades
2. It is easy to sell or buy assets in a liquid market, due to the quick and easy availability of market participants
3. Liquidity is more important in a slow or negative market when investors are ready to sell even at a loss
4. Large cap stocks are considered to be the most liquid assets in stock markets