Liquidity is an economics term defined as an asset’s ability to easily be converted in to cash. Money is, by far means, the most liquid asset. It is due to the fact that money could easily be converted in to cash and vice-versa.

Why is liquidity in the share market, important? It is a very important term used in the share markets, because of the fact that assets or underlying instruments must be easily converted in to cash. Traders must have a good view of liquidity, because this has higher effect on them.

Take an example of any asset or underlying. If it is illiquid, it becomes very difficult to trade.

For example, a stock ABC has been listed a year back with a share price of 1000 dollars. The stock has been growing gradually and so the share price. After one year, that is, at present, the share price of ABC stock is 1500 dollars.

The stock’s price has increased about 50 percent in a year. All this is about the company’s management, growth, fundamentals, technical and other factors that help in increasing the stock’s price.

Now, see all this from a trader’s perspective. You will be thinking “I am paying 1500 dollars for a share of ABC stock”. All the different types of questions will be coming to your mind:

1. If I will be in losses, how do I average my exposure to the stock as the share’s price is high?

2. I bought the stock. Now, how do I sell it?

3. I allotted less amount of money to this stock [say, 2500 dollars]. Now, I will be able to buy only 1 share and the remaining 1000 dollars will remain un-traded. How to take advantage of all the money in my account?

These questions are the major ones which will be moving in a trader’s mind. There are many other questions, though. Now, you will be getting an idea, why liquidity is important in a share market.

The share price of ABC is high and for the above reasons, traders will not get in to the stock. So, the stock will remain illiquid. There are some measures which will be taken by the company’s management to take care of the liquidity in it’s share price.

Now, let’s suppose the company’s management has come out with an excellent idea to split the share’s price in the ratio, 10:1. Now, ABC will be trading at a share price of 150 dollars.

What, about the liquidity? It will be coming back to the stock. All the three important questions will be answered now. The trader could average the stock.

He/she can easily sell the stock, or in other words, he could turn the asset easily in to cash, which means liquidity.

This is what liquidity means and hence, liquidity is important in a share market. Changing a stock in to cash easily will be done only if the stock is highly traded and is liquid.

Tags: asset, Buying, cash, company., Growth, illiquid, Liquidity, Management, selling, share market, stocks, why is liquidity in the share market important

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