What Number of Shares Determines Adequate Liquidity for a Stock? (original) (raw)

While there is no universal number of shares that determines adequate liquidity for a stock, there are certain metrics that help clarify how liquid or illiquid a stock might be.

Liquidity refers to how easy it is to buy and sell shares of a security without affecting the asset's price.

For example, if you bought stock ABC at 10andsolditimmediatelyat10 and sold it immediately at 10andsolditimmediatelyat10, then the market for that particular stock would be perfectly liquid. On the other hand, if you were unable to sell it at all, the market would be perfectly illiquid. Both of these situations rarely occur, so we generally find the market for a particular stock somewhere in between these two extremes.

Liquidity is more of a qualitative measure, meaning there is no one quantity of stock volume that can tell us how liquid an investment is.

Key Takeaways

• The liquidity of a stock is a reference to how easy or difficult it would be for a market participant to sell the stock without impacting the price.
• A stock that is very liquid has adequate shares outstanding and adequate demand from buyers and sellers. One that is illiquid does not.
• The bid-ask spread, or the difference between what a seller is willing to take and what a buyer wants to pay, is a good measure of liquidity. Market trading volume is also key.
• If the bid-ask spread is too large on a consistent basis, then the trading volume is probably low, and so is the liquidity.
• If the bid-ask spread is fairly small on a consistent basis, then the trading volume is probably high, and so is the liquidity.

Bid-Ask Spread and Volume

The bid-ask spread and volume of a particular stock are closely interlinked and play a significant role in the liquidity. The bid is the highest price investors are willing to pay for a stock, while the ask is the lowest price at which investors are willing to sell a stock. Because these two prices must meet in order for a transaction to occur, consistently large bid-ask spreads imply a low volume for the stock while consistently small bid-ask spreads imply high volume.

Liquidity Example

For example, a bid of 10andanaskof10 and an ask of 10andanaskof11 for stock ABC is a fairly large spread, meaning the buyer and seller are far apart. No transactions can take place until the buyer and seller agree on a price. Should this large bid-ask spread continue, few transactions would occur, and volume levels would be low, implying poor liquidity — either the bid or ask price (or both) would have to move for a transaction to take place.

On the other hand, a bid of 10andanaskof10 and an ask of 10andanaskof10.05 for stock ABC would imply that the buyer and seller are very close to agreeing on a price. As a result, the transaction is likely to occur sooner, and (if these prices continued) the liquidity for stock ABC would be high.