Stock Market Liquidity and the Benefits for Traders

Stock market liquidity is an important concept for traders to understand. Knowing the stocks that are easiest to convert to cash without the price being affected means you will be in a stronger position to buy and sell. In this piece, we’ll explore stock market liquidity in depth, reveal some of the most liquid stocks and the benefits of trading them, as well as covering the differences between stock market liquidity and FX liquidity.

What is liquidity in the stock market?

Stock market liquidity refers to the stocks that have sufficient trading volume to allow traders to enter and exit positions straightforwardly. Stocks that are not liquid and don’t have sufficient volume cannot be bought or sold as easily. This is simply because it’s harder to find buyers and sellers for such stocks.

Liquidity can be measured by share turnover, which is calculated by dividing the total number of shares traded over a given period by the average number of shares outstanding for the period. If a company has a high share turnover it will have liquid company shares.

For example, if a company on a major index such as NASDAQ, DAX 30 or FTSE 100 has 100 million shares outstanding on the first day of its fiscal year and 150 million on the last day, the average outstanding shares will be 125 million for the year. With a trading volume of 90 million shares for the year, the calculation is 90 million/125 million = 0.72, which expressed as a percentage is a share turnover of 72%.

What are the Most Liquid Stocks?

Examples of high liquidity stocks in the tech sphere include Microsoft, Google and Facebook, in e-commerce Amazon, Alibaba and Shopify, and in the energy sector Exxon, General Electric and Chesapeake Energy. The share volume of stocks refers to the number of shares that changed hands during a given day. The highest volumes will often be in the tens of millions, with stocks considered liquid around 200,000 and upward.

Naturally, the liquidity levels of stocks will vary, but for the most part the larger market capitalizations will have more liquid stocks. For a picture of the liquidity of stocks by sector, the following table shows some of the most liquid stocks as of April 2019.

Benefits of Trading Highly Liquid Stocks

Highly liquid stocks can be particularly beneficial for day traders – their sizeable trading volume means that positions can be entered and exited quickly without price being hit, suiting the rapid pace of the day trading experience.

Since liquid stocks enable the opening and closing of positions efficiently, traders can stay comfortably within their risk management strategy. Compare this to trading less liquid stocks, where it may take considerably longer to execute an order because their share volume is so low.

To find stocks with good liquidity, as with finding stocks that are volatile, you can use a stock screener tool. This helps find stocks according to specified criteria, in this case trading volume.

Relationship Between Liquidity and Fundamental and Technical Analysis

Trading volume can be affected strongly by fundamental and technical factors. An example on the fundamental side can be seen in the chart below, where subprime lender Provident Financial saw aggressive selling in August 2017 following a profit warning, the company scrapping its dividend and its CEO leaving.

Chart to show the relationship between trading volume and price movement at subprime lender Provident Financial. Source: IG.com

In terms of technical analysis, a significant price increase coupled with a notable increase in volume could indicate a continued bullish trend or bullish reversal. On the flipside, a price decrease along with a volume increase could be a sign of a continued bullish trend or bullish reversal.

Traders focusing on technical analysis may find volume indicators useful. The Positive Volume Index and Negative Volume Index are based on the previous day’s trading volume and market price and can be a useful way of showing how volume is affecting price.

Differences Between Stock Market Liquidity and FX Liquidity

When assessing the difference between stock market liquidity and forex or FX liquidity, it is important to note that all major currencies are highly liquid due to there always being a high volume of currency available to trade. The forex market operates 24 hours a day with trading averaging $5.1 trillion per day, according to the Bank for International Settlements. This means positions can be opened and closed round the clock, boosting liquidity further.

By comparison, while some stocks will have high liquidity such as the blue-chip examples above, smaller stocks with lower trading volumes can be significantly less liquid.

Other Trading Routes

If you’d rather not trade individual stocks, it may be worth considering trading the most liquid major stock indices such as the Dow Jones, S&P 500 and FTSE 100. Alternatively, as mentioned the forex market represents the most liquid choice of all.

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