An asset is considered liquid if it can be bought or sold quickly without affecting its price. An asset that can be sold rapidly for its full value is said to be highly liquid. An asset that takes significant time to sell, or one that can only be sold at a discounted value, is considered less liquid or illiquid.
Image source: The Motley Fool
Market liquidity and accounting liquidity are two related terms that refer to different concepts. Market liquidity is how easily a stock trades in the public markets, while accounting liquidity refers to a company's ability to pay its short-term obligations.
Both types of liquidity can be relevant to you as an investor, but a stock's market liquidity is generally what is implied when investors discuss liquidity. Keep reading to learn everything you need to know about liquidity.
Understanding market liquidity
Understanding market liquidity
A stock with market liquidity is readily available for purchase or sale. Another way to gauge a stock's market liquidity is to examine the difference between the asking price and the ultimate sale price -- also known as the bid-ask spread. If the price difference is insignificant, then the market for the stock is said to be fairly liquid.
Trading volume is another important indicator of stock liquidity. A stock that trades heavily has greater market liquidity. Stocks with high trading volumes are typically the easiest to sell.
Definition Icon
Volume in Stocks
Volume represents the number of shares traded during a defined period, typically a day.
Are stocks liquid assets?
Are stocks liquid assets?
Many segments of the stock market, like the market for large-cap stocks, are considered to be highly liquid. This is for a variety of reasons, including:
- High trading volumes
- Relatively tight bid-ask spreads
- Fast trade execution
Among the large-cap universe of stocks are many household names known for high liquidity. Apple (AAPL -0.21%), Tesla (TSLA -3.39%), and Facebook (NASDAQ:FB) are all great examples of highly liquid stocks.
Penny stocks, which are stocks that trade for $5 or less, are known to be relatively illiquid. Penny stocks tend to be thinly traded, have wide bid-ask spreads, and may be slow to sell -- particularly if you're trying to unload a large number of shares.
How to determine a stock's liquidity
How to determine a stock's liquidity
Analyzing a stock's liquidity is as much qualitative as it is quantitative. Your main considerations are:
- How narrow is the bid-ask spread?
- What is the average daily trading volume?
Using Starbucks (SBUX 0.85%) as an example, at the time of this writing, the bid-ask spread is a penny: $112.46-$112.47. This is an indication that the stock is extremely liquid, and a trade of any reasonable size does not impact the price.
Trading volume of at least 1 million shares daily is considered a sign of market liquidity. Starbucks' average trading volume during the past three months has been just over 6.5 million -- another sign that the market for Starbucks shares is highly liquid. Unless you're trading a sizable number of shares (in the hundreds of thousands), you can consider Starbucks stock to be liquid.
Examples of liquid stocks
Examples of liquid stocks
Below is a table of the 10 most liquid stocks, based on the average traded dollar volume:
Data source: Trading View. Data current as of May 24, 2021.| Company | 2021 Average Dollar Volume Traded |
|---|
| |
| Tesla, Inc. (NASDAQ:TSLA) | $314.7 billion |
| Amazon.com, Inc. (NASDAQ:AMZN) | $208.7 billion |
| Apple, Inc. (NASDAQ:AAPL) | $179.1 billion |
| Microsoft Corporation (NASDAQ:MSFT) | $103.1 billion |
| Facebook, Inc. (NASDAQ:FB) | $95.0 billion |
| NVIDIA Corporation (NASDAQ:NVDA) | $77.6 billion |
| Alphabet, Inc. Class A (NASDAQ:GOOGL) | $58.2 billion |
| Advanced Micro Devices, Inc. (NASDAQ:AMD) | $57.0 billion |
| Alphabet, Inc. Class C (NASDAQ:GOOG) | $48.7 billion |
| Micron Technology, Inc. (NASDAQ:MU) | $24.1 billion |
What is accounting liquidity?
What is accounting liquidity?
Accounting liquidity denotes the degree to which a company is able to pay its short-term obligations. (Short-term, in this context, is widely understood to mean 12 months.) Accounting liquidity is calculated by analyzing a company's financial statements, and typically the following metrics are calculated:
- Current ratio: The current ratio is found by simply dividing a company's current assets by its current liabilities. Current assets include cash and other assets the company expects to use or consume within a year, while current liabilities are the company's debts due within the next 12 months.
- Quick ratio: To calculate a company's quick ratio, add cash, marketable securities, and accounts receivable, and divide that sum by the company's current liabilities. This measure is used to determine the degree to which a company can quickly settle its current debts using only its quickly accessible assets.
- Acid-test ratio: The acid-test ratio is another way to measure a company's ability to quickly pay off its debts and is often calculated the same as the quick ratio. In another variation of the acid-test ratio, subtract the value of a company's inventory from its current assets and divide that amount by the company's current liabilities.
- Cash ratio: The cash ratio is simply a company's cash balance divided by its current liabilities.
How to Invest in ETFs for BeginnersExchange-traded funds let an investor buy lots of stocks and bonds at once.
How to Invest in Index Funds in 2024Index funds track a particular index and can be a good way to invest. Get a fast introduction to index funds here.
11 Best Passive Income IdeasPassive income is money you earn with minimal regular effort.
What to Invest in: Use Your Money to Make MoneyInvesting can be the most surefire path to becoming and remaining financially free. Here's how to get started the right way.
Why liquidity matters
Why liquidity matters
A stock's liquidity is mainly important because it indicates how easily investors can exit a position, while accounting liquidity helps investors gain a better sense of a company's financial flexibility.
Understanding the liquidity of your portfolio is a key component of risk management. If you can easily convert your stock holdings into cash, then you can settle unexpected expenses, even if the stock market broadly declines.
John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Sam Swenson, CFA, CPA has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Advanced Micro Devices, Alphabet, Amazon, Apple, Microsoft, Nvidia, Starbucks, and Tesla. The Motley Fool recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.
FAQs
Liquidity refers to how easily an asset can be bought or sold without significantly affecting its price. High liquidity means an asset can be quickly converted to cash at or near market price. Low liquidity indicates an asset may take longer to sell and could result in lower prices.
What is liquidity in simple words? ›
Definition: Liquidity means how quickly you can get your hands on your cash. In simpler terms, liquidity is to get your money whenever you need it. Description: Liquidity might be your emergency savings account or the cash lying with you that you can access in case of any unforeseen happening or any financial setback.
What is good liquidity for a stock? ›
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.
How much liquidity should I have? ›
Most financial experts suggest you need a cash stash equal to six months of expenses: If you need $5,000 to survive every month, save $30,000. Personal finance guru Suze Orman advises an eight-month emergency fund because that's about how long it takes the average person to find a job.
What does liquidity mean in trading? ›
Liquidity generally refers to how easily or quickly a security can be bought or sold in a secondary market. Liquid investments can be sold readily and without paying a hefty fee to get money when it is needed.
What is the best way to describe liquidity? ›
Liquidity definition
Liquidity is a company's ability to convert assets to cash or acquire cash—through a loan or money in the bank—to pay its short-term obligations or liabilities.
What is a liquidity risk for dummies? ›
What is Liquidity Risk? First, let's define liquidity. It's the amount of money businesses readily have available. Liquidity risk is defined as the risk of a company not having the ability to meet short-term financial obligations without incurring major losses.
Which stock has highest liquidity? ›
Top Liquid Stocks in India to Invest in 2024: High Liquidity Shares for your Portfolio
- State Bank of India.
- Bajaj Finance Ltd.
- Axis Bank Ltd.
- Maruti Suzuki India Ltd.
- ONGC.
- Adani Ports and Special Economic Zone Ltd.
- IOC.
- Indusind Bank Ltd.
A company's liquidity indicates its ability to pay debt obligations, or current liabilities, without having to raise external capital or take out loans. High liquidity means that a company can easily meet its short-term debts while low liquidity implies the opposite and that a company could imminently face bankruptcy.
How much liquidity should I have in my portfolio? ›
Cash and cash equivalents can provide liquidity, portfolio stability and emergency funds. Cash equivalent securities include savings, checking and money market accounts, and short-term investments. A general rule of thumb is that cash and cash equivalents should comprise between 2% and 10% of your portfolio.
A stock portfolio focused on dividends can generate $1,000 per month or more in perpetual passive income, Mircea Iosif wrote on Medium. “For example, at a 4% dividend yield, you would need a portfolio worth $300,000.
How much money do I need to invest to make $3 000 a month? ›
Imagine you wish to amass $3000 monthly from your investments, amounting to $36,000 annually. If you park your funds in a savings account offering a 2% annual interest rate, you'd need to inject roughly $1.8 million into the account.
How much money do you need to retire at age 50? ›
So to answer the question, we believe having one to one-and-a-half times your income saved for retirement by age 35 is a reasonable target. By age 50, you would be considered on track if you have three-and-a-half to six times your preretirement gross income saved.
Why is liquidity good for a stock? ›
Generally, yes, a higher liquidity is better for investors, as it can signal that a company is performing well, and that its stock is in demand. It can also be easier for an investor to sell that stock in exchange for cash.
What does liquidity look like in trading? ›
So in the forex market, liquidity pertains to a currency pair's ability to be bought and sold without causing a significant change in its exchange rate. A currency pair is said to have a high level of liquidity when it is easily bought or sold and there is a significant amount of trading activity for that pair.
What is an example of liquidity in trading? ›
Examples of liquidity
For instance, with a daily trading volume of over $5 trillion, forex is considered the largest and most liquid market in the world. Large stock markets, such as the New York Stock Exchange, are also considered highly liquid because thousands of shares change hands every day.
What is another term for liquidity? ›
fluidity. fluidness. runniness. aqueousness. “The liquidity of the river was evident as the water rushed swiftly downstream.”
What is liquidity in real life? ›
At its core, liquidity describes how easily an asset can be converted into cash without affecting its market price. It's the financial world's measure of readiness, the ability to meet obligations when they come due without incurring substantial losses.
What is liquidity and why is it important? ›
What Is Liquidity and Why Is It Important for Firms? Liquidity refers to how easily or efficiently cash can be obtained to pay bills and other short-term obligations. Assets that can be readily sold, like stocks and bonds, are also considered to be liquid (although cash is, of course, the most liquid asset of all).
What does liquidity refer to in a life? ›
Liquidity in life insurance refers to how easy it would be for you to access cash from your policy. While life insurance policies are structured to provide financial security to your beneficiaries upon your passing, some may allow you to access cash while you're still living — they would be considered more liquid.
