Liquidity refers to how easy it is to buy or sell something without affecting the price too much. For example, let’s say you want to sell a stock that you own. If the stock is highly liquid, it will be easy for you to find someone to buy it from you, and the price won’t change much when you sell it. But if the stock is not very liquid, it might be harder to find someone to buy it, and the price might change a lot when you try to sell it.
In finance, liquidity is important because it determines how easy it is for people to trade things like stocks, bonds, and currencies. The term “liquidity” comes from the Latin word “liquidus,” which means “fluid.” It’s used to describe financial markets and instruments that can flow smoothly, without any hiccups or problems.
Market makers are companies or individuals who make it possible for people to buy and sell financial instruments at any time. They do this by always offering to buy or sell at a certain price, which means that other people can trade with them whenever they want. For example, let’s say you want to buy a stock that isn’t very liquid. You might not be able to find someone who wants to sell it to you at a reasonable price. But if there is a market maker for that stock, they will be willing to sell it to you at any time, even if no one else is interested in buying or selling it. Market makers provide liquidity by always being willing to trade, so if someone wants to buy, the market maker will sell, and if someone wants to sell, the market maker will buy.
Having liquidity in a financial market or instrument is a good thing because it means that people can trade easily and without too much price volatility (sharp changes in price). On the other hand, if there isn’t much liquidity, it can be hard for people to buy or sell, and prices can be more unpredictable.
This page was last updated on May 24, 2023.