Liquidity: noticed only once it runs out

Liquidity is the ability to sell an asset quickly, in the size you need, without a meaningful concession on price. While markets are calm nobody thinks about it: orders fill instantly, the spread is narrow, everything works.

What it consists of

Trading volume, the number of participants on both sides of the book, and the width of the spread. All three are connected: the more participants, the denser the book and the smaller the gap between the buying and the selling price.

What the investor pays

Three things. The spread — every entry and exit costs half a spread each way. Slippage — a large order fills worse than the best quote. And the inability to exit — in an illiquid security on a falling market there may be no buyers at all.

Where to look

Daily turnover and the spread are visible on the instrument card:

Comparing it with a third-tier security usually shows a difference of several times over, not of a few percent.

The yield trap

Illiquid securities often look more attractive on multiples. In part that is payment for risk: for a holder to accept illiquidity, the asset has to be cheaper. The discount is not a market error but its price for a service the security does not provide.

What to do

Size positions against daily turnover. A position equal to several days of turnover is not sold with an order but with an operation — stretched over days and with a concession on price. On sizing, see How to assess the risk of a position, step by step; on orders, Market and limit orders: what speed costs you.