What Is Liquidity In Stock Market? How does this impact your trades?

What is Liquidity in Stock Market?

The liquid state of a matter has been explored in Physics, however, this term is different when it comes to the stock market.

So, what is liquidity in the stock market?

Let’s understand with an example. 

Suppose you’re planning to buy a refrigerator. You go to a nearby electronic shop, find one that suits you, purchase it by paying the price of the refrigerator in cash and move on.  

You see, how easy it is? This is because Cash is the most liquid financial asset. 

But, what is Liquidity? 

Read the blog to find out what is liquidity in the stock market, its types, and how to identify liquid stocks.  

Content: 

What Is Liquidity?

Liquidity is a term used to describe the ability to buy or sell an asset quickly and efficiently without affecting the market price. The more liquid an asset is, the easier it is to buy and sell it.

What Is Market Liquidity?

Market Liquidity is a parameter based on which you can determine how efficiently an asset can be bought and sold in the market at stable prices. 

A market is said to be more liquid when buyers and sellers trade easily at market prices. Buying and selling take place when there is enough demand and supply of assets in the market. 

On the other hand, the market is said to be less liquid if the number of sellers is more than the number of buyers, and vice versa. 

Due to such scenarios, sellers may suffer losses as they can’t sell their shares whenever they want to. The seller might have to compromise by selling it at a lesser rate than expected. 

Why Is Liquidity Important?

In the Stock Market, high levels of liquidity will not only ensure adequate numbers of supply or demand in the market, but it allows many trades to happen at one point in time.

Here, we are jotting down a few points that will make it easier for you to understand why is liquidity important. 

  1. Liquidity enables investors to execute buy and sell orders at the desired price more efficiently.
  2. Liquidity helps increase the number of active participants in the stock market because you will easily find buyers to sell your assets. 
  3. Liquidity smoothens the transaction process. 

Types Of Liquid Assets

The types of Liquid Assets are divided into two categories: 

  1. High Liquidity Assets:

  1. Cash 
  2. Cash Equivalents
  3. Stocks 
  4. Exchange-Traded Fund (ETF) 

    2. Low Liquidity Assets:

  1. Mutual Funds 
  2. Bonds 
  3. Certificates Of Deposits

Let’s get into each asset in detail: 

  1. High Liquidity Assets

These are assets that can be immediately traded without affecting their market value.

  1. Cash

Cash is considered the supreme liquid asset. It is an ever-friendly asset that can carry out any trade because it is highly accessible and acceptable in the market. The total amount of cash available to you equals the total amount of liquid assets you have.

Not only in the form of physical currency, but you can also use cash through your bank accounts, UPI links, or other payment apps. 

  1. Cash Equivalents 

As the name suggests, any asset that holds equal value as that of cash is known as Cash Equivalents. Bank accounts and marketable securities such as commercial paper and short-term government bonds are examples of cash equivalents.

As cash and cash equivalents are the most liquid assets, they are always shown on the top line of a company’s balance sheet.

  1. Stocks

Stocks represent the shares of a company that can be easily traded on stock exchanges by people like you and me. If you own stocks in a company, you own a part of that company in proportion to the number of shares you own. 

Stocks are highly liquid assets and can easily be traded using a demat and trading account.

In just a few easy steps, you can create an account with Alice Blue.

open demat account

If you are new to the concept of buying and selling stocks, then you must read our blog on How to buy shares online.   

  1. Exchange-Traded Fund (ETF) 

ETFs are investment funds that are traded in real time on stock exchanges just like stocks do. This makes ETFs a liquid asset and hence you can buy and sell them with ease. ETFs contain all types of investment securities, like stocks, commodities, currency, and bonds.

Examples of ETFs are Nippon India ETF Nifty BeES, HDFC Gold Exchange Traded Fund, etc. 

If you are planning to invest in ETFs, you can do it via Alice Blue. 

You just have to Open Demat Account and start investing in ETFs.

The prices of ETFs keep fluctuating throughout the day. They are bought and sold at any time on the stock market, thus making them highly liquid.

Please note: Not all ETFs are liquid. Eg. Bond ETFs. 

You’ll learn more about it in the next section. 

  1. Low Liquidity Assets

These are assets with fewer trading opportunities in the market. They are difficult and time-consuming to buy and sell.

  1. Mutual Funds

A mutual fund is a collection of securities, including stocks, bonds, and short-term debt. They are managed by asset management firms. 

Mutual funds collect money from investors and use it to buy different types of securities. The value of a mutual fund is based on the type of securities it chooses to purchase. 

They are traded once a day, as a result of which their liquidity is relatively lower than the rest of the financial assets. 

  1. Bonds

When you buy bonds, you are lending money to a company, the government, or any other organization. Many investors purchase bonds and hold them until they mature. 

This means that bonds are relatively lesser liquid than stocks but provide investors with returns at regular intervals.

  1. Certificates Of Deposits

The objective of a CD is to put in writing that you have invested your money in a bank for a certain amount of time. The bank will then pay you interest on that money. Interest is paid based on the amount and duration of time you put your money in the bank.

The certificate of deposit works as a savings instrument. As soon as the maturity period of your deposit is reached, the bank will pay your returns. 

For example, 

Malini invested Rs 5,000 in CD with a bank at a fixed interest rate of 5%. The term of maturity was 5 years. The returns and maturity value of the CD are calculated as below:

Year Amount Interest
0  5000   0
1 5255 255
2 5523 268
3 5805 282
4 6101 296
5 6413 312

So, at the end of the 5th year, Malini will receive Rs 6,413. The return on the CD for 5 years is Rs 1,413.

Now that we have understood what is liquidity and its types, let’s learn how to identify liquid stocks. 

How To Identify Liquid Stocks?

  1. Check if the trades you have planned for have the potential to execute quickly and efficiently. 
  2. When you plan your trade, make sure you are benefitted from the market trend. 
  3. Make sure there is less difference between the bid and asking prices. ‘Bid Price’ is the buyer’s price that they are willing to pay, and ‘Ask Price’ is the price that the seller says they are willing to take. If the difference between them is small, the stock is more liquid.

Illiquid Assets Meaning

If an investor finds it difficult to sell an asset due to inadequate number of buyers, it is said to be illiquid. They might have to face loss because, during the time of need, investors might not find suitable buyers as a result of which they have to settle with the price that is offered by the available buyers.

Illiquid assets are considered highly risky because it is challenging to find a suitable buyer for such assets. 

It is recommended that investors and traders do adequate research to avoid trading illiquid assets. Illiquid assets have less market depth, lower trading volume, and lower market value. 
Example: Private company interests, hedge funds, private equity, etc.

High Liquidity Stocks In India

According to the Nifty 50, the Top Liquid Stocks in India are stated in the table below. If you want to check the details by yourself, click on this link

SYMBOL OPEN HIGH LOW PREV. CLOSE LTP %CHNG VOLUME(Shares) VALUE(₹ Lakhs)
IDEA 9.15 9.45 9.1 9.25 9.2 -0.54 8,15,09,475 7,547.78
FRETAIL 6.4 7 6.4 6.7 7 4.48 6,21,79,274 4,259.28
ONGC 154.8 162.95 154.2 153.95 161.4 4.84 6,14,11,715 98,725.47
SUZLON 7.95 8.3 7.95 8.25 8.15 -1.21 4,94,22,447 3,998.28
MRPL 95.5 108.6 95.3 90.5 108.6 20 4,93,21,987 52,054.43
ZOMATO 69.7 69.7 64.75 69.9 65.2 -6.72 4,17,55,337 27,900.92
FCONSUMER 2.15 2.25 2.05 2.15 2.15 0 3,85,20,301 835.89
VISESHINFO 0.85 0.85 0.8 0.85 0.85 0 3,68,92,510 295.14
RPOWER 13.6 14.7 13.3 13.8 14.25 3.26 3,50,19,589 4,944.77
YESBANK 13.15 13.25 13.05 13.15 13.1 -0.38 3,11,23,663 4,083.42
OIL 279 301.2 274.35 278.9 277.4 -0.54 3,03,48,752 87,553.11
GTLINFRA 1.5 1.55 1.45 1.5 1.45 -3.33 2,89,09,516 424.97
JPPOWER 7.1 7.25 6.95 7.15 7.1 -0.7 2,43,51,230 1,724.07
RENUKA 52.8 54.75 52.45 53.4 53.25 -0.28 2,32,25,662 12,448.95
CHENNPETRO 340 385.3 338.05 321.1 365.75 13.91 1,83,87,025 68,100.02
SAIL 75 75.95 74.5 75.7 74.9 -1.06 1,82,18,210 13,692.81
RTNPOWER 3.95 4.05 3.85 4 3.95 -1.25 1,81,52,919 713.41
BANKBARODA 101.4 103.25 100.9 102.05 101.7 -0.34 1,75,22,351 17,837.75
IBULHSGFIN 114.35 120.6 114.35 116.1 117.9 1.55 1,68,44,813 19,782.55
ADANIPOWER 299.95 302.8 288.4 298.3 291 -2.45 1,58,24,786 46,820.79

The data was updated on June 07, 2022, 16:00:12 IST 

Illiquid Stocks List

According to the NSE, Illiquid Securities in India are stated in the table below. If you want to check the details yourself, click on this link

  SESSION 1(9:30-10:30) SESSION 2(10:30-11:30) SESSION 3(11:30-12:30) SESSION 4(12:30-13:30) SESSION 5(13:30-14:30) SESSION 6(14:30-15:30)  
SYMBOL PRICE QTY PRICE QTY PRICE QTY PRICE QTY PRICE QTY PRICE QTY AVERAGE PRICE TOTAL VOLUME TOTAL VALUE
TCIFINANCE 6.2 10 6.1 215 6.1 1,200 6.05 1,718 6.07 3,143 19,078.01
NORBTEAEXP 8.15 300 8.15 283 8.15 24 8.15 607 4,947.05
TARAPUR 4.25 50 4 100 4.08 150 612
CREATIVEYE

The data was updated on June 07, 2022, 15:14:26 IST 

Quick Summary 

  • Liquidity is a term used to describe the ability to buy or sell an asset quickly and efficiently without affecting the market price. The more liquid an asset is, the easier it is to buy and sell it.

  • Market Liquidity is a parameter based on which you can determine how efficiently a trade can be executed in the market.

  • Few points substantiating why liquidity is important are: 

    • Liquidity enables investors to execute buy and sell orders at the desired price more efficiently.
    • It helps to increase the number of active participants in the stock market.
    • It helps in balancing the risk and returns.
    • It smoothens the transaction process. 
    • Liquidity always acts as a multiplier of your cash reserve.

  • The types of Liquid Assets are divided into two categories: 

1. High Liquidity Assets:

        • Cash 

        • Cash Equivalents

        • Stocks 

        • Exchange-Traded Fund (ETF) 

2. Low Liquidity Assets:

        • Mutual Funds 

        • Bonds 

        • Certificates Of Deposits

3. The parameters based on which you can identify liquid stocks are: 

        • Check if the trades you have planned for have the potential to execute efficiently. 
        • While planning your trade, make sure you are benefitted from the market trend. 
        • Make sure there is less difference between the bid and asking prices.

4. When there aren’t enough buyers to match the number of sellers and vice versa, the market is said to be illiquid.

FAQ

  1. Which is the most liquid asset? 

Cash is the most liquid stock. It is an ever-friendly asset that can carry out any trade because it is highly accessible and acceptable in the market.

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About Author

Ashmita Saha

Ashmita Saha completed her Post Graduation from St. Joseph’s College in the domain of Journalism and Mass Communication. She has a strong profile of working with prominent media houses. After serving an EdTech company as a Content Head for a year, Ashmita has trodden towards the world of Financial Writing with her expertise in Copywriting, Blog Writing, and Social Media Marketing.

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