What is Liquid Stock? If you have read or heard somewhere about trading in the stock market. So there it is always asked to buy and sell liquid stock. Today big traders ask to trade in liquid stocks. Also the stock which does not have liquidity. So to trade in it, you are always advised to trade ‘No’.
Today many new traders have entered the stock market. Those who want to become financial independent by trading. In terms of trading, it is very important for you to know the meaning of liquidity.
Especially this article is beneficial for those retail traders who are from non-commerce background. The word liquidity in the stock market becomes a bit technical for them. Hence today’s article “What are liquid stocks and how to choose liquid stocks?” Learn about it in easy words. Let us first know what is meant by the word liquidity in the market.
What is Liquidity?
Liquidity means “liquidity” that how easily any asset can be bought and sold. That is, the more liquid an asset is, the more easily it can be bought and sold. On the other hand, if an asset is illiquid, it is more difficult to sell and buy it.
What is Liquid Stock?
Liquid stock means that any share can be easily bought and sold at any time. That is, whatever shares you have, can be easily converted into cash at the right time. Keeping an eye on stocks with good liquidity and trading or investing in them helps you to sell it easily whenever you have a huge profit.
If you trade or invest in illiquid stock, it may also happen that you may ever have to sell that share but no one will be found to buy it. That’s why professional traders and investors forbid you to trade or invest in such stocks. Because due to stock being illiquid, you may face difficulty in selling.
In the chart of liquid stocks, you get the body in every minute candle. This type of stock has good volume every single minute. Due to liquidity, the price of shares fluctuates every minute. Most penny stocks and low priced stocks do not have liquidity.
Why is Liquid Stock Important for Trading?
You must have known the meaning of liquidity. But have you ever wondered why liquid stocks are necessary for trading? Let us know how liquidity affects the market in two main ways:-
1. Price Spread
In finance, spread means the difference between two prices, rates, or yields. In simple words, price spread is the difference between buyer and seller orders in the market. It tries to tell us what is the difference between a buyer’s and a seller’s buy and sell price.
Liquid stock tries to bridge the gap between the buy price and the sell price. That is, the liquid stock has a low price spread. On the other hand, the gap between the buy price and the sell price in illiquid stock is very high. That is, illiquid stock has a high price spread. Hence it becomes difficult to buy and sell any share in illiquid stock.
2. Slippage
Slippage means “slippage” or “fall” . Whereas trading slippage means the difference between the expected price and the price at which the trade has been executed. By the way, the price of shares in the market fluctuates rapidly. Therefore slippage can happen at any time. But most of the time there is high volatility in the stock due to slippage. On the other hand the reason for this is also when a large quantity order is executed but at that time the price selected to maintain the spread between bid/ask price does not have volume. Let us tell you that the slippage is less in liquid stock than in illiquid stock.
We can divide the slippage into two types. One is a positive downside and the other a negative downside. A positive downside occurs when the ask price falls in a long trade and an increase in the bid price in a short trade. On the other hand, a negative downside occurs when there is an increase in the ask price in a long trade and a decrease in the bid price in a short trade.
How to choose Liquid Stocks for Trading?
It is necessary to have liquid stock for trading. It is important to have highly liquid stocks especially for intraday trading. Due to the volatility in the stock along with the volume, the liquidity of the stock increases. Let us then know how to choose liquid stocks for trading?
1. High Trade Volume
So, High volume in any stock means how many buys and sells have taken place on that stock in a day. High volume means that there should be high liquidity in that stock.
2. Less difference in Bid/Ask price
A small difference in the Bid/Ask price means that there are many buyers to buy that stock. On the other hand many sellers are present to sell that stock. This indicates less slippage and higher liquidity.
3. Choose stocks with medium volatility
If a stock has low liquidity ie no volatility at all. The stock that is completely choppy. Always stay away from them. But on the other hand, if the stock is more volatile, then the loss in it can be equally high. So choose stocks with medium volatility for trading. The risk in stocks with medium volatility is less than in stocks with high volatility.
Conclusion
From the point of view of traders, it is very important to have liquidity in the stock. Stocks with high liquidity can be easily bought and sold. Such stock can be quickly converted into cash. If there is no liquidity in a stock, you may lose a good opportunity.
Day traders should choose stocks with high liquidity. Because they have to do many deals in a day. On the other hand, due to lack of liquidity in the stock, you could not take many trades in a day. Illiquid stocks can cost you more than your risk capacity.
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