While there is no universal number of shares that determines adequate liquidity for a stock, there are certain metrics that help clarify how liquid or illiquid a stock might be.
Liquidity refers to how easy it is to buy and sell shares of a security without affecting the asset's price.
For example, if you bought stock ABC at $10 and sold it immediately at $10, then the market for that particular stock would be perfectly liquid. On the other hand, ifyou were unable to sell it at all, the market would be perfectly illiquid. Both of these situations rarely occur, so we generally find the market for a particular stock somewhere in between these two extremes.
Liquidity is more of a qualitative measure, meaning there is noone quantity of stock volume that can tell us how liquid an investment is.
Key Takeaways
- The liquidity of a stock is a reference to how easy or difficult it would be for a market participant to sell the stock without impacting the price.
- A stock that is very liquid has adequate shares outstanding and adequate demand from buyers and sellers. One that is illiquid does not.
- The bid-ask spread, or the difference between what a seller is willing to take and what a buyer wants to pay, is a good measure of liquidity. Market trading volume is also key.
- If the bid-ask spread is too large on a consistent basis, then the trading volume is probably low, and so is the liquidity.
- If the bid-ask spread is fairly small on a consistent basis, then the trading volume is probably high, and so is the liquidity.
Bid-Ask Spread and Volume
The bid-ask spread and volume of a particular stock are closely interlinked and play a significant role in the liquidity. The bid is the highest price investors are willing to pay for a stock, while the ask is the lowest price at which investors are willing to sell a stock. Because these two prices must meet in order for a transaction to occur, consistently large bid-ask spreads imply a low volume for the stock while consistently small bid-ask spreads imply high volume.
Liquidity Example
For example, a bid of $10 and an ask of $11 for stock ABC is a fairly large spread, meaning the buyer and seller are far apart. No transactions can take place until the buyer and seller agree on a price. Should this large bid-ask spread continue, few transactions would occur, and volume levels would be low, implying poor liquidity—either the bid or ask price (or both) would have to move for a transaction to take place.
On the other hand, a bid of $10 and an ask of $10.05 for stock ABC would imply that the buyer and seller are very close to agreeing on a price. As a result, the transaction is likely to occur sooner, and (if these prices continued)the liquidity for stock ABC would be high.
FAQs
While there is no universal number of shares that determines adequate liquidity for a stock, there are certain metrics that help clarify how liquid or illiquid a stock might be. Liquidity refers to how easy it is to buy and sell shares of a security without affecting the asset's price.
What is good liquidity for a stock? ›
What is good liquidity for a stock? Good liquidity for a stock means it has high trading volumes and narrow bid-ask spreads, allowing for easy buying and selling with minimal price impact. This ensures smooth transactions and stable pricing.
What stock volume is considered liquid? ›
An asset is considered liquid if it can be bought or sold quickly without affecting its price. An asset that can be sold rapidly for its full value is said to be highly liquid. An asset that takes significant time to sell, or one that can only be sold at a discounted value, is considered less liquid or illiquid.
What is the liquidity level of a stock? ›
This spread represents the difference between the highest price a buyer is willing to purchase the stock for and the lowest price the seller is willing to sell it. A tighter bid-ask spread typically indicates higher liquidity, which means you likely can sell the stock quickly without a significant drop in its value.
How to determine liquidity? ›
Types of liquidity ratios
- Current Ratio = Current Assets / Current Liabilities.
- Quick Ratio = (Cash + Accounts Receivable) / Current Liabilities.
- Cash Ratio = (Cash + Marketable Securities) / Current Liabilities.
- Net Working Capital = Current Assets – Current Liabilities.
A company with a liquidity ratio of 1 — but preferably above 1 — is in good standing and able to meet current liabilities. Anything below 1 means the business will have issues paying debts.
Is 2 a good liquidity ratio? ›
Liquidity ratios are important to investors and creditors to determine if a company can cover their short-term obligations, and to what degree. A ratio of 1 is better than a ratio of less than 1, but it isn't ideal. Creditors and investors like to see higher liquidity ratios, such as 2 or 3.
What are the criteria for stock liquidity? ›
A stock that is very liquid has adequate shares outstanding and adequate demand from buyers and sellers. One that is illiquid does not. The bid-ask spread, or the difference between what a seller is willing to take and what a buyer wants to pay, is a good measure of liquidity. Market trading volume is also key.
How much liquidity should I have? ›
Most financial experts suggest you need a cash stash equal to six months of expenses: If you need $5,000 to survive every month, save $30,000. Personal finance guru Suze Orman advises an eight-month emergency fund because that's about how long it takes the average person to find a job.
What is the best indicator for liquidity? ›
Current, quick, and cash ratios are most commonly used to measure liquidity.
A good current ratio is between 1.2 to 2, which means that the business has 2 times more current assets than liabilities to covers its debts. A current ratio below 1 means that the company doesn't have enough liquid assets to cover its short-term liabilities.
Which stock has the highest liquidity? ›
Top Liquid Shares for Intraday Trading: Meaning, Factors & Risks
- State Bank of India.
- Bajaj Finance Ltd.
- Axis Bank Ltd.
- Maruti Suzuki India Ltd.
- ONGC.
- Adani Ports and Special Economic Zone Ltd.
- IOC.
- Indusind Bank Ltd.
The bid-ask spread is the gap between the ask price and the bid price of a share. In simple terms, it is the difference between the lowest price that a seller may accept for a share and the highest price that a buyer will pay for it willingly. However, it is a de facto measure of liquidity.
What is the formula for liquidity of a stock? ›
They estimate the liquidity measure as the ratio of volume traded multiplied by the closing price divided by the price range from high to low, for the whole trading day, on a logarithmic scale. The authors use the price at the end of the trading period because it is the most accurate valuation of the stock at the time.
What is the rule of liquidity? ›
A fund is required to determine a minimum percentage of its net assets that must be invested in highly liquid investments, defined as cash or investments that are reasonably expected to be converted to cash within three business days without significantly changing the market value of the investment.
What is the basic liquidity ratio? ›
To calculate this ratio, divide a company's total cash and cash equivalents by its total current liabilities. Here, a higher ratio indicates that the company has enough liquid assets to cover all its short-term obligations without selling any other assets. A cash ratio of 1:1 or greater is generally considered healthy.
Is a liquidity ratio of 5 good? ›
Generally, a good Liquidity Ratio should be above 1.0. This indicates the company has enough current assets to cover its short-term liabilities. A higher Liquidity Ratio (above 2.0) shows the company is in a stronger financial position and may have spare cash available for investments or other opportunities.
What is considered high liquidity stocks? ›
High liquidity means that there are a large number of orders to buy and sell in the underlying market. This increases the probability that the highest price any buyer is prepared to pay and the lowest price any seller is happy to accept will move closer together. In other words, the bid-offer spread will tighten.
What is the ideal liquidity? ›
In short, a “good” liquidity ratio is anything higher than 1. Having said that, a liquidity ratio of 1 is unlikely to prove that your business is worthy of investment. Generally speaking, creditors and investors will look for an accounting liquidity ratio of around 2 or 3.
