Introduction
Stock market liquidity is a fundamental concept that traders need to grasp in order to make informed decisions while buying and selling stocks. It is essential to understand which stocks can be easily converted to cash without impacting their prices. This knowledge puts traders in a stronger position to execute successful trades. In this detailed article, we will delve deep into the concept of stock market liquidity. We will also explore some of the most liquid stocks, understand the benefits of trading highly-liquid stocks, and analyze the differences between stock market liquidity and FX liquidity.
What is Liquidity in the Stock Market?
Stock market liquidity refers to the level of trading activity in stocks, indicating their ability to be bought or sold without causing significant price fluctuations. Highly liquid stocks have sufficient trading volume, allowing traders to enter and exit positions smoothly. In contrast, less liquid stocks face challenges in finding buyers and sellers, making it difficult to execute transactions at desired prices.
Liquidity is commonly measured using the share turnover ratio. This ratio is calculated by dividing the total number of shares traded over a specific period by the average number of shares outstanding during that period. A higher share turnover indicates higher liquidity. For example, if a company’s fiscal year begins with 100 million shares outstanding and ends with 150 million shares outstanding, and the trading volume during the year is 90 million shares, the share turnover ratio would be 0.72 or 72%.
Examples of Highly Liquid Stocks
In different sectors, there are several highly liquid stocks available for trading. In the technology sphere, companies like Microsoft, Google, and Facebook are known for their high liquidity. In the e-commerce sector, Amazon, Alibaba, and Shopify are considered highly liquid stocks. The energy sector offers stocks like Exxon, General Electric, and Chesapeake Energy with significant trading volume.
While the liquidity levels may vary among stocks, it is generally observed that stocks with larger market capitalizations tend to have higher liquidity. These blue-chip stocks attract more market participants, which in turn increases liquidity. To provide an overview of sector-wise stock liquidity as of April 2019, refer to the following table:
- Energy:
- Chesapeake Energy
- ExxonMobil
- Halliburton
- Financial:
- Bank of America
- Berkshire Hathaway
- Blackstone Group
- Lloyds Banking Group
- Healthcare:
- Celgene
- Johnson & Johnson
- Merck & Co.
- Pfizer
- Teva
- Industrials:
- CSX Corp
- Deere & Co
- KKR & Co
- US Ecology
- Technology:
- Amazon
- Apple
- Cisco
- Intel
- Telecoms:
- AT&T
- Comcast
- T-Mobile US
- Verizon
- Vodafone
Benefits of Trading Highly-Liquid Stocks
Highly-liquid stocks offer numerous advantages, particularly for day traders who engage in rapid buying and selling. The significant trading volume of highly-liquid stocks enables traders to enter and exit positions quickly without triggering substantial price shifts. This speed and efficiency align with the fast-paced nature of day trading.
Moreover, trading highly-liquid stocks facilitates effective risk management. Since liquid stocks allow for swift position execution, traders can promptly implement their risk management strategies. In contrast, less liquid stocks can lead to delays in executing orders due to low trading volume.
Traders can identify highly-liquid stocks by employing stock screeners that filter stocks based on specific criteria such as trading volume. These tools contribute to streamlining the stock selection process for liquidity-focused traders.
Relationship Between Liquidity and Fundamental and Technical Analysis
A company’s fundamental and technical factors can significantly influence trading volume, thereby impacting liquidity. For instance, a fundamental factor like a negative profit warning, the elimination of dividends, or the departure of key executives can trigger aggressive selling and reduce liquidity in stocks.
From a technical analysis perspective, notable price movements accompanied by significant changes in trading volume can signal ongoing bullish trends or potential reversals. Conversely, price declines coupled with increased trading volume can indicate bearish trends or possible reversals. Volume indicators, such as the Positive Volume Index and Negative Volume Index, serve as tools in technical analysis to assess the relationship between volume and price movements.
Differences Between Stock Market Liquidity and FX Liquidity
While both stock market and foreign exchange (FX) markets involve the concept of liquidity, there are key differences between the two.
The foreign exchange market, being the largest financial market globally, boasts high liquidity. Major currency pairs like EUR/USD and EUR/JPY are highly liquid due to the abundant availability of currencies for trading. In contrast, exotic currency pairs such as USD/HUF and USD/TRY witness lower liquidity, as their trading volumes are comparatively limited.
Furthermore, the FX market operates round the clock, enabling continuous trading with constant liquidity. According to the Bank for International Settlements, the average daily trading volume in the forex market is around $6.6 trillion, significantly higher than the trading volume of stocks. The 24-hour nature of the forex market makes it highly convenient for traders seeking liquidity at any time.
However, it is important to note that many stocks also exhibit high liquidity, particularly large-cap stocks like blue-chip companies mentioned earlier. Conversely, smaller stocks with lower trading volumes tend to have lower liquidity compared to major stocks.
Other Trading Routes
If individual stock trading does not appeal to traders, there are alternative trading options available that offer high liquidity.
One such option is trading major stock indices, such as the Dow Jones, S&P 500, and FTSE 100. These indices represent baskets of stocks, which collectively offer more liquidity than individual stocks traded within them.
Alternatively, traders can participate in the highly liquid forex market. With its exceptional liquidity, the forex market allows for seamless buying and selling of currencies, offering a diverse range of trading opportunities for market participants.
More on Equities
To further enhance your understanding of stocks and the stock market, we offer additional resources that delve into various aspects:
- Beginner’s Guide to Stock Trading: A comprehensive guide for individuals who are new to stock trading.
- Types of Stocks: An overview of different types of stocks available in the market, including common, preferred, and growth stocks.
- Researching Stocks: Insights into the process of conducting thorough research on stocks, exploring various analysis techniques and tools.
By exploring these resources, you can enhance your knowledge and make more informed decisions when engaging in stock market activities.
In conclusion, stock market liquidity plays a crucial role in trading, and understanding it is essential for traders. This article has provided a detailed analysis of stock market liquidity, covered examples of highly liquid stocks, emphasized the benefits of trading liquid stocks, explored the relationship between liquidity and fundamental and technical analysis, compared stock market liquidity with FX liquidity, suggested alternative trading routes, and recommended additional resources for expanding knowledge on equities.