While there is no universal number of shares that determines adequate liquidity for a stock, there are certain metrics that help clarify how liquid or illiquid a stock might be.
Liquidity refers to how easy it is to buy and sell shares of a security without affecting the asset's price.
For example, if you bought stock ABC at $10 and sold it immediately at $10, then the market for that particular stock would be perfectly liquid. On the other hand, ifyou were unable to sell it at all, the market would be perfectly illiquid. Both of these situations rarely occur, so we generally find the market for a particular stock somewhere in between these two extremes.
Liquidity is more of a qualitative measure, meaning there is noone quantity of stock volume that can tell us how liquid an investment is.
Key Takeaways
- The liquidity of a stock is a reference to how easy or difficult it would be for a market participant to sell the stock without impacting the price.
- A stock that is very liquid has adequate shares outstanding and adequate demand from buyers and sellers. One that is illiquid does not.
- The bid-ask spread, or the difference between what a seller is willing to take and what a buyer wants to pay, is a good measure of liquidity. Market trading volume is also key.
- If the bid-ask spread is too large on a consistent basis, then the trading volume is probably low, and so is the liquidity.
- If the bid-ask spread is fairly small on a consistent basis, then the trading volume is probably high, and so is the liquidity.
Bid-Ask Spread and Volume
The bid-ask spread and volume of a particular stock are closely interlinked and play a significant role in the liquidity. The bid is the highest price investors are willing to pay for a stock, while the ask is the lowest price at which investors are willing to sell a stock. Because these two prices must meet in order for a transaction to occur, consistently large bid-ask spreads imply a low volume for the stock while consistently small bid-ask spreads imply high volume.
Liquidity Example
For example, a bid of $10 and an ask of $11 for stock ABC is a fairly large spread, meaning the buyer and seller are far apart. No transactions can take place until the buyer and seller agree on a price. Should this large bid-ask spread continue, few transactions would occur, and volume levels would be low, implying poor liquidity—either the bid or ask price (or both) would have to move for a transaction to take place.
On the other hand, a bid of $10 and an ask of $10.05 for stock ABC would imply that the buyer and seller are very close to agreeing on a price. As a result, the transaction is likely to occur sooner, and (if these prices continued)the liquidity for stock ABC would be high.
FAQs
While there is no universal number of shares that determines adequate liquidity for a stock, there are certain metrics that help clarify how liquid or illiquid a stock might be. Liquidity refers to how easy it is to buy and sell shares of a security without affecting the asset's price.
What measures the liquidity of a stock? ›
The liquidity of stocks varies greatly based on three primary factors, including its trading volume, bid-ask spread and the efficiency of its respective market. When comparing various stock investment options, it's important to evaluate the stock's liquidity by assessing these three factors.
How do you calculate share liquidity? ›
Share turnover is a measure of stock liquidity, calculated by dividing the total number of shares traded during some period by the average number of shares outstanding for the same period. The higher the share turnover, the more liquid company shares are.
How to determine liquidity? ›
Types of liquidity ratios
- Current Ratio = Current Assets / Current Liabilities.
- Quick Ratio = (Cash + Accounts Receivable) / Current Liabilities.
- Cash Ratio = (Cash + Marketable Securities) / Current Liabilities.
- Net Working Capital = Current Assets – Current Liabilities.
An asset that can be sold rapidly for its full value is said to be highly liquid. An asset that takes significant time to sell, or one that can only be sold at a discounted value, is considered less liquid or illiquid.
What is a good liquidity ratio? ›
A good liquidity ratio is anything greater than 1. It indicates that the company is in good financial health and is less likely to face financial hardships. The higher ratio, the higher is the safety margin that the business possesses to meet its current liabilities.
What is a good measure of liquidity? ›
Cash is the most liquid of assets, while tangible items are less liquid. The two main types of liquidity are market liquidity and accounting liquidity. Current, quick, and cash ratios are most commonly used to measure liquidity.
What is the liquidity of shares? ›
A stock's liquidity generally refers to how rapidly shares of a stock can be bought or sold without substantially impacting the stock price.
What is the value of liquidity? ›
Liquidity is the degree to which a security can be quickly purchased or sold in the market at a price reflecting its current value. Liquidity in finance refers to the ease with which a security or an asset can be converted into cashat market price.
What are the best ratios to measure market strength? ›
The price-to-earnings (P/E) ratio is quite possibly the most heavily used stock ratio. The P/E ratio—also called the "multiple"—tells you how much investors are willing to pay for a stock relative to its per-share earnings.
Liquidity Ratios Defined
In essence, a liquidity ratio is a snapshot of your firm's ability to pay its short-term debt obligations. Specifically, this type of metric indicates whether your firm can cover existing debts with existing assets without raising external capital or leveraging fixed assets like real estate.
What is the rule of liquidity? ›
A fund is required to determine a minimum percentage of its net assets that must be invested in highly liquid investments, defined as cash or investments that are reasonably expected to be converted to cash within three business days without significantly changing the market value of the investment.
What factors determine liquidity? ›
Additionally, liquidity also depends on many macroeconomic and market fundamentals. These include a country's fiscal policy, exchange rate regime as well the overall regulatory environment. Market sentiment and investor confidence are also key to improving liquidity conditions.
What is a good volume for stocks? ›
To reduce such risk, it's best to stick with stocks that have a minimum dollar volume of $20 million to $25 million. In fact, the more, the better. Institutions tend to get more involved in a stock with daily dollar volume in the hundreds of millions or more.
What does liquidity mean? ›
Liquidity is a company's ability to convert assets to cash or acquire cash—through a loan or money in the bank—to pay its short-term obligations or liabilities. How much cash could your business access if you had to pay off what you owe today —and how fast could you get it? Liquidity answers that question.
How do you calculate days to liquidate? ›
Defined as the number of days it would take for the portfolio to liquidate the entire position of a stock based on the average daily trading volume. This is calculated by taking the # of shares held by the portfolio and dividing it by the Average Daily Trading Volume over the last 3 months.
Which stock has high liquidity? ›
Liquid Stocks
| S.No. | Name | CMP Rs. |
|---|
| 1. | Hindustan Zinc | 518.50 |
| 2. | B P C L | 604.40 |
| 3. | Jupiter Wagons | 484.55 |
| 4. | I O C L | 157.30 |
12 more rowsThe volume for any particular securities can be measured easily, given that the number of buyers and sellers is in good numbers. Liquidity, on the other hand, means the ease with which a security can be sold or bought in the market.
