Liquidity is a very important concept to understand when attempting to trade and invest in the stock market. Essentially, liquidity represents the ease with which financial instruments like stocks and options can be traded. Liquidity is the volume of trading activity that allows a trader to buy or sell a security or derivative and receive fair value for it. When you have a high volume of people active in a particular market, it provides the trader with an opportunity to move in and out of positions without difficulty.

For instance, when you are at-the-money in the options market, options typically have tremendous liquidity because they have a better chance of being profitable than out-of-the-money options. Therefore, they are easier to trade, which is why many traders focus exclusively on the at-the-money contracts. The bottom line is that a lot of action and trading translates into opportunity.

In order for traders to discern where the action really is, there are a few things they can do to avoid illiquid markets, such as reviewing the market’s volume to see just how many shares or contracts have actually been traded. This is widely distributed data both The Wall Street Journal and Investors Business Daily report volume changes on a regular basis as well as many Internet sites. It has always been key information for the trader to know whether volume is increasing or decreasing. Typically, a measurement of liquidity is if the stock is trading at least 300,000 shares per day. For futures markets it is best to monitor activity daily and choose a market that trades many more contracts than you trade.

Of course these are just general rules of thumb and certainly as you gain more trading experience you will encounter situations when theses rules can be tossed out the window in exchange for common sense. The important thing to remember about liquidity is that a plentiful number of buyers and sellers and an elevated volume of trading activity provide high liquidity, which gives you the opportunity to move in and out of a market with ease. Illiquid markets can make the process much more difficult and more costly. Profitable markets are those markets that provide opportunity for making good returns on investments. Obviously, some markets are more trader friendly than others and liquidity is a very important factor in making a particular market so.

Happy Trading.


Jeff Neal
Senior Writer, Options Strategist & Profit Strategies Radio Show Market Correspondent
Visit Jeff’s Forum
Listen to Jeff at www.ProfitStrategiesRadio.com

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