Glossary
Liquidity
How quickly and cheaply an asset can be bought or sold without moving its price; deep markets have tight spreads.
Liquidity describes how easily something can be turned into cash at a fair price. A liquid asset can be bought or sold quickly, in size, at a price close to the last trade; an illiquid one forces you to wait, accept a discount, or both. The word has a second meaning in company analysis: a firm's ability to pay its short-term bills from cash and assets that will soon become cash.
How market liquidity is measured
No single number captures it, so traders look at several:
- Bid-ask spread: the gap between the best price to sell and the best price to buy.
- Trading volume: how many shares or contracts change hands per day.
- Depth: how many shares are offered at prices near the best quote.
- Price impact: how far a given order size moves the price.
Why it matters
Low liquidity is a hidden cost and a hidden risk. It raises the price of every trade, makes stop orders fill far from their trigger, and can trap holders when they most want to sell. Liquidity is also not constant: it thins in the first minutes after the open, in extended hours, around news and during market stress, exactly when many investors rush for the exit at once.
For companies, accounting liquidity is judged with the current ratio and quick ratio. A profitable business can still fail if it runs out of cash to meet payroll and debt payments.