What Is Liquidity?


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Liquidity defines how easily a given item of value can be converted into cash.  Currencies for example, are 100% liquid assets as they are already in cash form.  Whether the currency is that of the United States (USD) or Great Britain (GBP) the rule of asset liquidity holds the same: they are both cash, and already therefore can be utilized immediately.  Liquidity is an important component of investment as it defines how easily one can exchange their stocks or bonds into real cash should they need it.  Liquidity is also present in the housing markets, vehicle sales, in generally any sort of asset transfer.  If a given asset’s liquidity is low, same story with a stock’s liquidity, it will lower its inherent value.  This is because an item of value that cannot easily be converted to cash is essentially a risk.  The risk is that the liquidity will impede the owner’s availability to unload the asset if they need to do so quickly.  For example, an antique car may have an appraised value of $150,000 however if there exists few people with either the financial means or the desire to buy it, the asset liquidity is low and the car is therefore essentially worth less.  It is worth less because should the owner need cash in a hurry they will most likely need to sell that antique car at a heavy loss, essentially unloading it to get better liquidity.

Stock Market Liquidity

Stock liquidity is not always understood clearly.  It usually becomes apparent to the average uninformed investor when they see a stock sale made from their account for an amount less than they thought.  For example if you have stock in Ford and see it trading for $5.50 a share, you may call your broker and tell them to sell.  When you check your account you see that your stocks in Ford were in fact sold but that you only received $5.45 per share, losing $.05 on each stock you sold.  Why?  Stock liquidity.  Just the same as the general principle of asset liquidity, stock liquidity follows the same rule: there must be a willing buyer to pay the amount you want or the market says your stock is valued at.  If none exists, meaning lowered stock liquidity, you will take a loss.

Related posts:

  1. What Is A Forward?
  2. The Currency Basket
  3. What Is Curreny Appreciation?
  4. What Is A Spread?
  5. What Is A Limit Order?

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