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Liquidity is the ability to buy or sell an asset quickly and without significant price changes. The higher the liquidity, the easier and faster it is for the trader to execute trades at the desired price. It is ensured by the presence of a large number of buyers and sellers in the market, active trading and a narrow spread.
Whether you're interested in day trading, stock trading, or Forex trading, understanding the concept of liquidity can help you to magnify your profits. This article discusses “why is liquidity important” and different aspects that affect market liquidity. Read everything carefully that’s discussed below in order to perform educated and informed trading. So, let’s dive into it.
The liquidity meaning remains the same, although it’s defined differently in different contexts. According to the liquidity definition, it’s defined as the degree or extent to which you can buy or sell a particular asset in the market quickly at a price that describes the asset’s intrinsic value. In simple words, it’s about getting your hand on your money whenever you need it. In the trading world, cash is known as the most liquid asset because you can convert it into other assets most easily and quickly.
While making your investment decisions, assessing liquidity can help you a great deal since it directly affects your trades. Moreover, liquidity allows you to determine how fast you can access the market you’re interested in and how quickly you can earn money by trading a specific asset.
Why Does Liquidity Matter in Trading?
Trading liquidity is an important factor for a variety of reasons. The most crucial aspect is that it influences how quickly an investor may purchase or sell a particular security. A liquid market is often thought to be less risky. As a result, traders and investors can easily find a party to purchase or sell their holdings. Therefore, being a trader or investor, you can quickly find a buyer in the liquid market without having to lower the price of your position or security. If you're a buyer, then you’ll also have a desired security or position fast without dealing with increased prices.
Another critical aspect to keep in mind concerning market liquidity is that it is not always fixed. The liquidity of any position depends on a variety of different factors, such as trading volume and the time of trading. For example, you will discover less liquidity on currency pairings, including GBP, if you perform a trade during the Asian trading period. Therefore, it is vital to consider liquidity as it enables you to reach your investing and financial goals as quickly as possible.
Some of the reasons how liquidity assists you are mentioned below:
It significantly reduces the time between putting a position for sale and getting an interested buyer.
Liquid securities and assets simplify the selling process in comparison with illiquid positions, which are particularly helpful in emergencies and critical situations.
The liquid positions, unlike illiquid ones, tend to retain the intrinsic market value.
In order to find out the liquidity level of any given asset, different ratio formulas are used to calculate the liquidity ratio. The most common ratio formulas that traders used are discussed below with examples.
The Current Ratio
The current ratio, which is also known as the working capital ratio, describes the number of times a business can use its assets in order to pay its existing liabilities. This method is the easiest one that can help novice traders and beginners a great deal, and it's calculated as follows:
Current Ratio = (current assets of a business) / (current liabilities of a business)
Example
Let's suppose a business's current assets, including cash and inventory, are worth 150,000 US dollars. The total liabilities of the business are worth 100,000 US dollars. So, the current capital ratio will be:
Current Ratio = 150,000 US dollars / 100,000 US dollars = 1.5
Quick Ratio
The quick ratio, which is also known as Acid Test in another great yet more conservative way to calculate liquidity. Instead of including current inventory, the quick ratio includes marketable securities, account receivables, and cash equivalents. It’s calculated by using the following formula.
Quick Ratio = current assets of a business (except inventory) / (current liabilities of a business)
Example
Let's imagine a business's current liabilities are worth 100,000 US dollars and its current assets excluding inventory are 75,000 US dollars. So, the quick ratio will be:
Capital Ratio = 75,000 US dollars / 100,000 US dollars = 0.75
It means that the business will need to sell its inventory in order to meet its obligations.
Cash Ratio
Another method that investors use to calculate liquidity is the cash ratio which is also known and Net Working Capital. It's also considered to be the most conservative way to measure liquidity. In this method, along with excluding the existing inventory value of the business, you'll also need to exclude the business's account receivables. It means that this method emphasizes only the cash resources of the business. It's calculated as follows:
Cash Ratio = current assets of a business (except account receivables and inventory) / (current liabilities of a business)
Example
Let's say the cash resources or current assets of a business (except account receivables and inventory) are 25,000 US dollars, and the current liabilities are worth 100,000 US dollars. So, the Cash ratio will be:
Cash Ratio = 25,000 US dollars / 100,000 US dollars = 0.25
From the above examples, you can easily deduce that the more cash that a business holds in hand, the higher the liquidity ratio. Generally, if the calculated liquidity ratio is higher than 1, then it means that the company you want to trade-in is well-placed, and the associated trading risk is low.
It's also important to note that the liquidity ratio much greater than 1 is also not good. It's known as a liquidity glut, and it shows that the company doesn't have enough spending with too many assets. Moreover, the value of less than 1 shows that the company is struggling to pay off its debts and can be bankrupted.
You can find all the important figures that you need to use in the formulas mentioned above in the company’s balance sheet or public financial reports.
Forex Liquidity Example
In the Forex market, the concept of liquidity is the same, and it illustrates the ability of any Forex pair such as EUR/USD to be sold or bought on demand. For example, the most commonly traded currency pairs are highly liquid. Therefore, it’s obvious that not all the currency pairs available in the Forex market are highly liquid. The fact of the matter is that different currency pairs show changing levels of liquidity at different times. The Forex liquidity gets higher when you move from minor currency pairs to major ones. Some of the exotic and major currency pairs of all times, along with their daily turnover as listed below.
EUR/USD: Average daily turnover - 1.173 trillion US dollars.
USD/JPY: Average daily turnover - 902 billion US dollars.
GBP/USD: Average daily turnover - 470 billion US dollars.
USD/CHF: Average daily turnover - 409 billion US dollars.
USD/CAD: Average daily turnover - 275 billion US dollars.
AUD/USD: Average daily turnover - 249 billion US dollars.
NZD/USD: Average daily turnover - 229 billion US dollars.
Example
For example, GBP/USD is one of the most traded currency pairs in the Forex market that flaunts an average daily turnover of about 470 billion US dollars. You can easily determine that it has high liquidity. But when you compare it with USD/JPY, then you'll find that it's still far less liquid than that. Moreover, GBP/USD is still not impressive as EUR/USD comes with a daily turnover of more than 1 trillion US dollars, making it the most liquid and traded currency pair in the whole world.
Factors Influencing Market Liquidity
The liquidity of any asset depends upon multiple factors such as interest rates, the current price, rules and regulations of central banks, the number of assets in circulation, etcetera. Another important factor is the class of asset. For instance, real estate is way less liquid as compared to equities. Moreover, the liquidity of other assets such as commodities and derivatives usually depends upon the number of exchanges people use to trade them as well as their size.
In general, the instruments which are traded on popular and major exchanges are highly liquid. Whereas the instruments which are traded on less-developed or small markets are generally illiquid.
It’s also important to note that the liquidity of a market is also affected by the time of the day you choose to perform trading. For example, you’ll surely experience better selling or buying prices if you plan to trade currency pairs that involve EUR during the official hours of all the European exchanges. On the other hand, if you plan the same currency pair during Asian trading hours, then you will face less liquidity.
For example, the total trading volume of Google on 9th October 2020 was 1.3 million US dollars which seems a lot. But on the same day, the total trading volume of Tesla Motors was 42 million US dollars. Both of the stocks are highly liquid, but the Google stocks showed lower liquidity on that day as compared to Tesla Motors stocks. It's also important not to trade the shares that have daily trading volume in two or three figures because they're often considered to be illiquid.
The Most Liquid Trading Instruments Rating
If you’re looking for the most liquid and active instruments for trading, then it's critical to perform your due diligence. There are several factors that you need to consider in order to ensure that the instrument you're choosing is highly liquid. But for your convenience, we have performed the required market research and selected the most active and liquid trading instruments for different markets.
US Stocks
Consider reading the following table carefully that contains the most liquid US stocks that you can choose for trading.
Instrument
Code
Open
Bullish
Bearish
Total
Tesla Inc
NASDAQ: TSLA
10312
1039
533
138619
Apple Inc
NASDAQ: AAPL
13634
697
137
85977
Amazon.com Inc.
NASDAQ: AMZN
9686
331
74
45219
NIO Inc A ADR
NYSE: NIO
2380
1072
110
43438
NVIDIA Corp
NASDAQ: NVDA
5394
669
124
24503
ETFs
If you're interested in ETFs (Exchange Traded Funds), you can choose the following most liquid ones.
Instrument
Code
Open
Bullish
Bearish
Total
SPDR S&P 500
NYSEARCA: SPY
1451
113
42
8360
Invesco QQQ Trust
NASDAQ: QQQ
662
54
16
4952
United States Oil
NYSE: USO
316
13
3
3635
ProShares UltraPro Short QQQ
NASDAQ: SQQQ
341
45
15
2952
ARK Innovation
NYSE: ARKK
122
70
26
3009
Forex
The following are the most liquid currency pairs according to their current performance that you can choose for trading.
Instrument
Open
Bullish
Bearish
Total
EUR/USD
203727
2857
2241
541043
GBP/USD
74918
1446
1074
264625
USD/JPY
57930
725
522
166981
AUD/USD
29833
493
410
99212
USD/CAD
27814
581
372
90863
Cryptocurrencies
Check out the following table that contains the most liquid cryptocurrencies with their respective currency pairs and other important information.
Cryptocurrency
Pair
Price
Volume
Liquidity
Bitcoin
BTC/JPY
34,411.39 US dollars
79.62 percent
394
Ethereum
ETH/JPY
2,113.64 US dollars
7.39 percent
290
USD Coin
USDC/USD
1.00 US dollar
0.54 percent
440
XRP
XRP/JPY
$0.7262 US dollars
5.07 percent
232
Celsius
CEL/USDC
6.12 US dollars
0.45 percent
190
Where to Trade Liquid Markets
One of the most important factors that can make or break your trading experience is the selection of online brokerage. Not only do you need to make sure that you choose the broker with an affordable and suitable fee and commission structure, but you also need to ensure that it allows you to access the big and famous markets with highly liquid instruments. The whole process of choosing the right only brokerage can be very cumbersome. That's why we have selected the best online brokers that are not only perfect for accessing the market with highly liquid instruments but are also regulated and highly trusted. Moreover, you can choose them for trading to achieve your financial goals regardless of your trading experience. Other than the online brokers, we have also selected an online crypto exchange that you can choose to perform cryptocurrency trading.
Online Brokers to Trade Liquid Markets: Comparison Table
Forex is one of the most liquid trading markets in the whole world because it’s one of the most popular types of trading as well. FxPro is the best platform when it comes to accessing the market that offers currency pairs with high liquidity. It offers a staggering 70 different types of currency pairs, including all the major ones. Moreover, it supports 8 different base currencies, including USD, EUR, GBP, AUD, and JPY.
It was created back in 2006, and now it's regulated by multiple world-famous financial bodies such as FCA, CySEC, SCB, and FSCA.
If you're interested in stock trading, then you would want to access the US stock market because it's the most liquid one across the globe. The best online broker that allows you to access the US stock market with highly liquid stocks is Webull. You can use this trading platform to trade US stocks, ETFs, and options.
Webull is relatively a new trading platform as compared to other popular players as it was founded in 2017. But within a very short period of time, this brokerage has acquired authorizations, and it's regulated by renowned financial bodies such as FINRA and SEC, which makes it a trusted and low-risk online trading platform.
When it comes to cryptocurrency trading, then there is no better option than Binance. Choosing the right place to perform crypto trading is critical because here, the liquidity not only depends upon the underlying trading pair but also depends on your exchange.
Binance is by far the best place where you can access more than 150 different types of cryptocurrencies. Moreover, the platform is also available in about 180 different countries and offers the best crypto trading experience.
Summary
As you can see, liquidity is one of the most critical financial concepts that can make or break your trading experience. It plays a vital role in the contemporary financial markets' stability. It's true that liquidity is more important, particularly for the traders with large position sizes and accounts. But if you're a beginner, then you should invest in instruments with high liquidity that will allow you to start trading instruments in large sizes within the shortest period of time. We hope that this guide will help you to understand how liquidity works and how it can help you to maintain your confidence.
FAQ
What is the most liquid asset?
There's no doubt that cash is by far the most liquid asset. Other than that, all the marketable securities also have high liquidity, and they include bonds and stocks that are listed on reputable exchanges.
Is liquidity always good?
Generally, liquidity is good, but too much liquidity can cost you in the long run. It shows that a certain organization is overly focused on liquidity by limiting its spending, especially on expansion.
What determines the market liquidity?
Market liquidity is usually determined by multiple factors such as the current price, the number of assets in circulation, interest rates, and rules by central banks.
How to analyze liquidity?
The easiest and simplest way to analyze liquidity is to use the current ratio or capital ratio formula, which is calculated by dividing the current assets of a business by the current liabilities of a business.
Alamin Morshed is a contributor at Traders Union. He specializes in writing articles for businesses who want to improve their Google search rankings to compete with their competition.
Over the past four years, Alamin has been working independently and through online employment platforms such as Upwork and Fiverr, and also contributing to some reputable blogs. His goal is to balance informative content and provide an entertaining read to his readers.
His motto is: I can dream or I can do—I choose action.
Glory is a professional writer for the Traders Union website with over 5 years of experience in creating content in the areas of NFT, Crypto, Metaverse, Blockchain, or Web3 in general. Over the last couple of years, Glory has also traded on different cryptocurrency and NFT platforms including Binance, Coinbase, Opensea, and others.
“I understand a lot about this space, being familiar with CEX, DeFi, and DEX, as well as operating across the Ethereum, Binance, and Polygon networks. Also, I know the intricacies and subtleties of NFTs and crypto, thus I am able to bring to table the best content and help connect with the audience better.”
Mirjan Hipolito is a journalist and news editor at Traders Union. She is an expert crypto writer with five years of experience in the financial markets. Her specialties are daily market news, price predictions, and Initial Coin Offerings (ICO). Mirjan is a cryptocurrency and stock trader. This deep understanding of the finance sector allows her to create informative and engaging content that helps readers easily navigate the complexities of the crypto world.
