What Is Liquidity?
Liquidity is how easily you can buy or sell a stock quickly without moving its price. How to judge it from volume, spreads and depth, with a worked example of what thin liquidity costs.
Liquidity is how easily an asset can be bought or sold quickly, in reasonable size, at a price close to its last trade. A highly liquid stock trades constantly with tight prices, while an illiquid one may take time to trade and can cost you noticeably more on the way in and out.
How to judge a stock’s liquidity
Three signals tell you most of what you need:
- Trading volume: how many shares change hands per day. Large companies on major exchanges often trade millions of shares a day, while some small stocks trade only a few thousand.
- Bid-ask spread: the gap between the highest price a buyer will pay (the bid) and the lowest price a seller will accept (the ask). Tight spreads usually mean good liquidity. See the bid-ask spread explained.
- Depth: how many shares are waiting at each price in the order book. Shallow books mean a large order can push the price.
A worked example
You buy 1,000 shares and then immediately change your mind and sell them.
| Liquid stock | Thinly traded stock | |
|---|---|---|
| Bid / ask | $10.00 / $10.02 | $4.80 / $5.00 |
| Buy 1,000 at the ask | $10,020 | $5,000 |
| Sell 1,000 at the bid | $10,000 | $4,800 |
| Round-trip cost | $20 (0.2%) | $200 (4.0%) |
The thin stock costs twenty times as much in percentage terms, before any commission. If the order book held fewer than 1,000 shares at the bid, selling would push the price lower still. A limit order protects you from filling at a much worse price than you expected, at the risk of not filling at all.
Liquidity can disappear
Liquidity is not fixed. It thins out in pre-market and after-hours sessions, around surprise news, and during market stress. In January 2021, the SEC staff report on the GameStop episode found that GameStop’s average relative effective spread on January 28 was 0.54%, three times its 2020 average of 0.18%. Liquidity tends to be scarcest exactly when the most people want to sell.
Two meanings of the word
In company analysis, liquidity means something different: whether a business has enough cash and short-term assets to pay its bills, measured by figures such as the current ratio on the balance sheet. This entry covers market liquidity, the ease of trading the shares.
Related: Bid-Ask Spread Explained · Stock Order Types · How Stock Prices Are Set
Stay in the loop
New explainers, by email
One short email when a new plain-English explainer goes up. No price tips, no "next 100x coin", no selling your address. Unsubscribe any time.