Liquidity is an important concept in the financial market. It has major connotations in a In the sense of macroeconomics and microeconomics. In a macro, fluidity is defined as general flow of money that is affected by the central bank.
On the other hand, in microeconomics, liquidity refers to The available width of the asset in a certain period.
For example, in forex trading, pairs like EUR/USD and GBP/USD are popular, which means you can buy and sell them easily. There will always be counterparties to these securities.
On the other side, some coins Pairs Called exotic like TRY/BRL (Turkish Lira vs. Brazilian Real) or SGD/TRY (Singapore Dollar vs. Lira) It is often poorly traded. Most of the brokers who offer these pairs only see a handful of activity on a given day.
The same situation occurs in the stock market, where some stocks such as Apple and Microsoft are actively traded compared to other small and unknown companies such as Expion360 and Takurn Art.
What is liquidity?
As mentioned above, liquidity refers to the total volume of an asset available in the market. It’s an important metric because of it Vital influence among traders. In addition to stocks and forex, liquidity is also an important part of other assets, such as cryptocurrencies and bonds.
In cryptography, it is estimated that there are over 21,000 digital currencies in the world today. The most popular of them are Bitcoin, Ethereum, and Ripple.
For these, it is relatively easy to trade as there will always be counterparties. On the other hand, there are some coins and tokens that are trading poorly.
How does liquidity affect the markets?
have liquidity important role In the market three Main Reasons. Firstly, Trading low liquidity assets is usually more expensive from others. this It is more popular in the forex industrywhere brokers do not charge a commission but make money using the price difference between the bid and ask.
For highly liquid pairs such as EUR/USD and GBP/USD, transaction costs are usually minimal. On the other side, For illiquid couples such as SGD/TRY, The total transaction cost is usually relatively high. For US stocks, brokers like Schwab and Robinhood do not charge transaction fees.
Liquidity also affects Total time to execute the trade. For large-volume assets, trades are executed at lightning speed because there is always a counterparty on the other side. On the other hand, for low-volume assets, there is usually a slight delay, which may affect profitability.
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Moreover, liquidity can have value role in market manipulation. In most periods, it is very difficult to manipulate stocks like Apple and Microsoft which have a daily volume of billions of dollars.
that it It is easy to manipulate companies with poor turnover Worth a few million dollars. In some cases, some brokers may cancel some trades due to low liquidity.
Finally, liquidity affects volatility from an asset. Some thinly traded assets may have some big market moves.
How to determine if a stock is liquid or not
So, how do you determine whether or not a stock or other asset is liquid? there Three main ways To determine if the stock is liquid or not.
First, there Know the company name. For hugely popular companies like Apple, Meta Platforms, and Alphabet, liquidity is never an issue.
However, if you select a small, unknown company, it is likely that their liquidity will always be lower.
The next thing to check is the The relative size of the companywhich are usually provided by most companies, including brokerages such as Robinhood and Schwab.
stock with Small relative size means it has low fluidity over time. It is relatively easy to determine the size of assets in the financial market.
Finally, there The spread of supply and demand from an asset. In stocks, you likely won’t see these distinctions. But it is popular in forex. If you see a currency pair with poor spreads, this is a sign that they have low liquidity.
Pros of trading low liquidity assets
There are many benefits to trading low liquidity assets. First, those Assets can be hidden gems Because most of the traders don’t follow them. According to Peter Lynch, it is always possible to make a lot of money from assets that most people avoid.
Secondly, there is a habit No or limited competition In the market. As a result, you can use your experience and expertise to find opportunities in such assets. Finally, you can Use the volatility of these assets to get an advantage In the market.
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Low liquidity stock trading methods
There are several strategies to use when trading low liquidity stocks. Firstly, Always do your research on the original prior to executing the transaction. This research can include fundamental or technical analysis.
Second, you should Always place a stop loss and take profit order When trading these assets due to the risk of volatility.
Finally, always trade it in When there is an important event that moves the market such as earnings or economic data.
risk of low liquidity
As mentioned above, there are many risks to trading low liquid stocks and other assets. These risks include:
Expensive to trade
As a trader it is always important that you do this Focus on transaction costs. Unlike investors, you are likely to execute dozens of trades per day. As such, the total transaction cost can be high.
Therefore, trading low liquid assets tends to be costly in most cases Because of wider margins.
Pumping and discharging schemes
Weakly traded stocks and cryptocurrencies Ready for pump and dump schemes. This happens because traders who have a limited amount of money can have a major role in stocks.
For example, a trader with a $100,000 account can easily transfer a company’s stock with a market capitalization of about $1 million.
Likewise, the merchant and A group of traders can handle a small cryptocurrency. On the other hand, stocks like Microsoft and Google are relatively difficult to manipulate.
Analysis challenge and exit points
always difficult to analyze Low liquidity assets such as stocks and cryptocurrencies. In most cases, these assets tend to lack major catalysts and news.
Also, in technical analysis, it is almost impossible to incorporate volume into it.
Finally, there Limited exit points Especially when low-liquid assets are also range bound. It would be difficult to trade such financial assets.
Low liquidity assets are in most cases more than the highly liquid ones. In this article, we have explained what liquidity is and how it works in the market. We’ve also looked at how to trade low-liquid stocks and other assets.