What is Liquidity in Stocks?

January 15, 2023

What is Liquidity in Stocks?

If you're interested in learning about how liquidity can impact stocks and are wondering whether to purchase low or high liquidity stocks, simply continue reading to discover a basic guide to market liquidity.

What is liquidity in stocks:

In simple terms a stock's liquidity indicates how quickly it can be bought or sold without its price being affected. However, as an investor you may want to think about liquidity in terms of how easy a stock is to sell.

High liquidity stocks are generally easy to sell and can be quickly sold at any time, while low liquidity stocks are often in low demand and can be notoriously difficult to sell in a hurry.

One simple way to get a fair indication of how liquid a stock currently is to take a look at its bid and ask spread. If the spread accounts for less than 1% of the stock price, the stock which you're looking at can be classed as a liquid stock or a high liquidity stock.

Examples of popular liquid stocks:

johnson & Johnson Stock

Some examples of liquid stocks include stocks from:

How is liquidity measured:

Liquidity is measured by the trading volume of shares in a single day of trading. Liquid or high liquidity stocks are frequently traded in large numbers while low liquidity stocks are traded in lower numbers at a less frequent rate.

Key reasons to purchase stocks with high liquidity:

If you plan on investing some of your disposable income into stocks, which you want to be able to access quickly in an emergency, it's in your best interests to purchase stocks with high liquidity.

As stocks which have low liquidity can be difficult to sell quickly. You should be able to sell high liquidity stocks in a few hours.

One of the benefits of purchasing high liquidity stocks is that they are still easy to sell regardless of the stock market's overall performance.

Key reasons to purchase stocks with low liquidity:

You may be wondering why individuals may want to invest in low liquidity stocks when it may be hard to sell low liquidity stocks quickly.

However, there are a few advantages of purchase low liquidity stocks:

  • As a key example, low liquidity stocks usually have higher expected returns than high liquidity stocks. 
  • As when it comes to purchasing stocks, the higher your risk is, the higher your expected returns should be.

If you can't afford to lose all of the money which you plan on investing, it's far safer to invest in easy to sell, high liquidity stocks than hard to sell, low liquidity stocks.

However, you should never invest money which you can't afford to lose as all investments carry an element of risk.

Building a diversified stock portfolio:

One of the safest ways to incorporate low liquidity stocks which could bring in high returns, is to purchase them as part of a diversified stock portfolio which also features high liquidity stocks.

That way if you require money in a hurry for an emergency or to invest in a time sensitive opportunity, you'll be able to sell some of your low liquidity stocks to acquire the capital which you require in a hurry.

Another way to offset your risk is to purchase other asset classes as well as stocks such as property shares, gold and silver shares and low risk ETF shares.

While low liquidity stocks are associated with higher elements of risk, it's still a wise idea to incorporate low liquidity stocks into your stock portfolio as if you only purchased high liquidity stocks your potential to bring in high profits would be low.

As purchasing low liquidity stocks as part of a balanced stock portfolio will increase your chances of making a high return from your stock portfolio.

Consider your individual appetite for risk before purchasing new stocks:

Also remember to factor in your individual appetite for risk, before purchasing new stocks. As your circumstances are unique.

  • For example, if you are a young professional who wants to retire early, you may be more inclined to purchase low liquidity stocks which offer potential high returns. If you end up losing some of the capital which you invest, you will still have decades to invest for your retirement.
  • On the other hand, if you're closer to retirement age, you may want to purchase fewer low liquidity stocks in order to decrease your risk as an investor.

In order to decide on the percentage of your stock portfolio which should be comprised of low liquidity stocks and the percentage of your stock portfolio which should be comprised of high liquidity stocks, it's critical to sit down and write out your long-term financial goals.

Liquidity ratings can give you an accurate picture of a company's financial health:

When you're purchasing stocks, looking at each stock's liquidity rating will give you an overall picture of each company's current financial health.

Try to look for stock's which have a current liquidity rating of one or higher. As companies which have a liquidity rating of one or higher are far less likely to face financial hardship or fold.

Remember that the higher a company's liquidity rating is, the more likely it will be able to meet its financial obligations. As an example, if a particular company has high debts and low cash reserves it's likely that they'll have a low liquidity rating.

In conclusion:

Now that you're well aware of the benefits and risks which are associated with purchase low liquidity shares and high liquidity shares, you'll be able to purchase stocks which meet your intended level or risk and reward.

If you are interested in purchasing low liquidity stocks which offer the potential for high returns, ensure to balance out your stock portfolio with high liquidity stocks. To decrease the risk and volatility of your stock portfolio.

Also remember to look at a stock's liquidity rating in order to see how likely it's associated company is likely to survive any financial hurdles.

Other Recommendations

Over the years I've reviewed DOZENS of Investment newsletters. As a result of this, I've also spent quite a bit of time doing reviews of my FAVORITE Stock & Investment Newsletters, which you can read below!

I recommend checking out The Power Gauge ReportLouis Navellier’s Growth Investor, Fry's Investment Report, Commodity Super Cycles & of course the Oxford Income Letter.

These are all created by experts at the VERY top of their game, and are 100% worth checking out!

About the author 

Jenna Lofton, an expert in stock trading, investing, and financial planning, combines over a decade of experience with rigorous academic training. Holding dual MBAs in Finance and Business Administration from the University of Maryland, Jenna's expertise is grounded in a deep understanding of the financial markets. Her career, which started on Wall Street, has evolved into empowering others through her insights and analyses in the dynamic world of finance.

Based in New York City, Jenna's approach is informed by her hands-on experience as a former financial advisor and her keen observation of market trends. She is known for translating complex financial concepts into actionable strategies, making her a valuable resource for both seasoned investors and newcomers to the stock market. Her commitment to financial literacy and her ability to demystify investment principles have made her a respected and authoritative voice in the investment community.

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