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Benefits of Stock Market Liquidity for Traders

by Elena Martin   ·  October 22, 2022  

Benefits of Stock Market Liquidity for Traders

by Elena Martin   ·  October 22, 2022  
Understanding stock market liquidity is crucial for traders. You will be in a better position to acquire and sell if you are aware of the simplest stocks to convert to cash without the price being impacted. This article will examine stock market liquidity in detail, highlight some of the most liquid equities and discuss the advantages of trading them, as well as how stock market liquidity differs from FX liquidity.

WHAT DOES STOCK MARKET LIQUIDITY MEAN?

Liquidity in the stock market refers to equities with enough trading volume to let traders enter and exit positions without difficulty. Stocks with insufficient volume and low liquidity cannot be purchased or sold as readily. It isn’t easy to locate buyers and sellers for such stocks.

Share turnover, computed by dividing the total number of shares exchanged during a particular time by the typical number of shares outstanding for the period, may be used to gauge liquidity. A corporation will have liquid company shares if there is a significant share turnover.

liquidity

For instance, if a corporation listed on a significant index like the NASDAQ, DAX, or FTSE 100 has 100 million outstanding shares on the first day of its fiscal year and 150 million on the final day, the average number of outstanding shares for the year will be 125 million. 90 million shares were traded throughout the year; therefore, 90 million/125 million = 0.72 represents a share turnover rate of 72%.

WHICH STOCKS ARE THE MOST LIQUID?

Exxon, GE, and Chesapeake Energy are examples of high-liquidity stocks in the energy industry. Microsoft, Google, and Facebook are examples of high-liquidity stocks in e-commerce. The amount of shares traded on a particular day is the share volume of stocks. With equities deemed liquid at 200,000 and above, the biggest volumes will often be in the tens of millions.

Naturally, there will be variations in the liquidity of stocks, but generally speaking, the equities with higher market capitalizations will be more liquid. The following table displays some of the most liquid equities as of April 2019 to provide an overview of the liquidity of stocks by sector.

ENERGYFINANCIALHEALTHCAREINDUSTRIALSTECHNOLOGYTELECOMS
Chesapeake EnergyBank of AmericaCelgeneCSX CorpAmazonAT&T
ExxonMobilBerkshire HathawayJohnson & JohnsonDeere & CoAppleComcast
General ElectricBlackstone GroupMerck & Co.United TechnologiesCiscoT-Mobile US
HalliburtonKKR & CoPfizerUS EcologyGoogleVerizon
TransoceanLloyds Banking GroupTevaWaste ManagementIntelVodafone

ADVANTAGES OF TRADING HIGHLY LIQUID STOCKS

Highly liquid stocks may be beneficial for day traders since they allow for quick entry and exit of positions without hitting prices, which is ideal for the fast-paced nature of day trading.

Since liquid stocks make it easy to establish and close positions, traders may confidently stick to their risk management approach. Contrast this with trading less liquid equities, where it could take a lot longer to complete an order due to the low share volume.

You may use a stock screener tool to identify companies with solid liquidity, just as you can find volatile stocks. This assists in locating equities based on predetermined parameters, such as trading volume.

RELATIONSHIP BETWEEN LIQUIDITY AND TECHNICAL AND FUNDAMENTAL ANALYSIS

Fundamental and technical considerations have a significant impact on trading volume. In the chart below, a subprime lender named Provident Financial saw intense selling in August 2017 due to a profit warning, its dividend abolition, and its CEO’s departure. This is an illustration of fundamentals in action.

liquidity

According to technical analysis, a hefty price gain and a noticeable volume increase might signify the continuation of a bullish trend or a positive reversal. On the other hand, a price decline accompanied by an increase in volume may indicate a continuation of the positive trend or a bullish reversal.

Volume indicators could be helpful for traders that prioritize technical analysis. The Positive Volume Index and Negative Volume Index are important indicators of how volume influences price since they are based on the trading volume and market price from the previous day.

DIFFERENCES BETWEEN FX LIQUIDITY AND STOCK MARKET LIQUIDITY

There are a few crucial aspects to consider when comparing the currency market’s liquidity with the stock market. Due to the constant availability of a large amount of money for trading, all main currencies, including EUR/USD and EUR/JPY, are very liquid; nevertheless, exotic currencies, such as USD/HUF and USD/TRY, are exchanged considerably less often.

According to the Bank for International Settlements, the forex market trades an average of $6.6 trillion daily, many times more than the volume of equities. It is open 24 hours a day. Additionally, this implies that positions may be established and terminated at any time, which is beneficial for liquidity.

However, many equities, including the aforementioned blue-chip examples, will naturally also have significant liquidity. Despite this, smaller stocks with fewer trades may be much less liquid.

ALTERNATIVE TRADE ROUTES

Consider trading the most liquid major stock indexes, such as the Dow Jones, S&P 500, and FTSE 100, if you’d prefer not to trade individual equities. As an alternative, the foreign exchange market is the most liquid option.