Liquidity is a key element of a good investment opportunity. It refers to how easy it is to trade a commodity or a financial instrument. If liquidity is high the chances of making a profit grow. In low liquidity markets trading can be risky and you might be left holding the bag nobody wants. Therefore, when choosing where you want to take your business, choose markets and investments where liquidity is high.
Let us illustrate that with the way we choose a restaurant. Do you go for the empty restaurant or the one with a queue around the block? Stupid question, but why do you make that choice. Various reasons, right? First you guess that if everybody wants to eat there it must have good food. The shelf life of food there is likely to be short also, making the chances of finding fresh food higher.
Something similar happens to investment options. It is not a case of investing where everybody else is investing. That could be a big mistake. You want to be ahead of the market, riding the trend, not a stupid cow being herded by the masses. However, you also want to make sure you are in an investment you can sell quickly in case you find yourself in prickly position.
In order to get a feel of the liquidity of a certain financial instrument there is nothing better than visiting the exchanges. Check out the actual trading pits where orders and sales are placed. If you see an empty pit with two guys twiddling their thumbs, that is a low liquidity market. Avoid like the plague. However if you see two hundred men, in a pit ten feet wide, yelling at each other and making what seems like very rude gestures, you are probably looking at a great investment opportunity.
This is because you need volume in order to create a good investment opportunity. You also need to have the option of move in and out of positions without difficulty. The easier it is to buy and sell the higher the chances of making a profit.
So, if you are planning to invest a specific market, check the volume of trading and how liquid it is. Again, avoid illiquid markets.
But, how can you tell if a market is liquid or not. Well, if you cannot actually visit the pits where sales are being made you can check the Wall Street Journal, the Investor’s Business Daily or your favorite financial website. It is difficult to give a specific quantity that describes a liquid market, but it is a good idea to keep to stocks that are trading at least 300,000 a day. It is important to understand that markets change daily. What is a liquid market today can quickly change tomorrow. As a successful trader you must keep your finger on the pulse at all times, or your investment might just die in an illiquid market.
