The importance of liquidity when it comes to buying and selling shares

Julie Brownlee, Fsp Invest, 11 May. 2015

Tags: liquidity, what is liquidity, stock market, stock market liquidity, liquidity of shares, stock market, shares,

When it comes to the financial markets, you may have heard the term liquidity.

So what does liquidity mean? And should it be something to concern yourself with?

Read on to find out…

What is liquidity?

Liquidity describes how easy it is to buy or sell an investment, such as shares.

Let’s say you want to buy shares in a company. To do this, you instruct your stock broker to buy these shares on your behalf.

Your stock broker then has to find someone who wants to sell those shares so that the trade happens.

It works the same way when you want to sell shares. You instruct your stock broker, who then has to find someone willing to buy those shares so the sale takes place.

The liquidity of a share will dictate how easy this is for your stock broker to do.

When liquidity can be a problem

If you buy and sell the biggest shares on the Johannesburg Stock Exchange, such as Sasol and MTN, liquidity is likely to seldom be a problem.

The companies that make up the Top 40 Index on the JSE see millions of their shares changing hands each day.

A problem with liquidity may crop up when you invest in small companies, especially when you want to sell.

If you stock broker can’t find a willing buyer for your small company shares, you may have to consider cutting your selling price significantly to facilitate the sale. And this could result in heavy losses for you.

What about the liquidity of the stock market?

There can be times when the liquidity of the overall market is low. This tends to happen in times of market turmoil.

During times like this, you may struggle to sell shares and other securities that are generally easy to part company with.

In times of market crisis, the only securities that tend to retain their liquidity is safe haven securities like US and UK government bonds.

So there you have it. The importance of liquidity when it comes to buying and selling shares.

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