Volume vs Liquidity
These are just two important and more prominent factors that investors keep in mind while making investment decisions.
What is Volume vs. Liquidity?
Volume or volume of trade is the number of shares traded in the stock market over a particular period. Therefore, the period for which we measure the trading volume is crucial.
Trade volume is the total quantity of the shares or contracts sold for a particular security. It indicates how often the investors have indulged in the security, that is, the simultaneous selling and buying of the stocks.
The volume for any particular securities can be measured easily, given that the number of buyers and sellers is in good numbers.
Liquidity, on the other hand, means the ease with which a security can be sold or bought in the market. Since the security liquidity is high, retail investors can easily believe it in the market.
The liquidity of a stock suggests how rapidly security can be bought and sold without significantly influencing the market’s functioning. Therefore, the more liquidity, the easier it is to deal with the particular security.
Liquidity risk is when investors will not find a market for their stocks or securities, which may prevent them from buying or selling particular securities. This may make their stakes unsold or sold at an undesirable price that would be very low.
Note
Liquidity and volume are widely misunderstood concepts that need clarification from the investors and traders community.
High volume represents a higher number of executed orders or higher trading transactions. However, high liquidity means the ease at which the stock can be traded. More closer the liquidity, the lesser the market impact cost and the higher the market efficiency.
Higher liquidity can sometimes become high volumes if the active buyers or sellers who place the market order are aggressive. Moreover, a low trading volume does not mean inferior liquidity.
Let us dwell more into the concepts of the two terms.
Understanding Volume Vs. Liquidity
One must understand what liquid and illiquid markets are. Market liquidity directly impacts the bid-offer spread until the securities are bought or sold.
Liquidity, as discussed before, is the convenience with which securities can be dealt with in the financial markets. That means that they should be easily bought and sold in the market and at stable prices without impacting the market prices.
It is measured by looking into the volume of current trades and the pending ones in the market. One of the unique traits of a liquid market is that some buyers and sellers are always ready to buy and sell respectively.
Note
Market liquidity is necessary for many reasons, but primarily because it affects how quickly the positions can be opened and closed.
A liquid market is generally associated with less risk, as someone is always willing to take the other side of a given position. This can tempt speculators and investors to the market, which adds to the advantageous market conditions.
Speculators and investors take a vital position in the market as they are willing to bear a higher risk for higher returns. In contrast, investors are risk averse and usually like to stay invested for a long time.
In a liquid market, a seller will easily find a buyer willing to buy at the price they are offering the stock. Consequently, a buyer will find a seller offering the store at the price they are ready to buy.
It is liquidity that helps in determining the spread of that particular asset. High liquidity indicated many orders to buy and sell in the underlying market. This ensures that the bid-offer spread gets tightened as the price offerings on the buyers’ and the sellers’ sides keep moving closer.
If the market is illiquid, that would mean that the bid-offer spread is vast, and the sellers and buyers cannot match their offer prices.
We are talking about volume.
Volume is one of the first instincts behind any stock. It indicates the interest in the trading of that particular stock or securities. Heavier volume implies more interest in dealing with the store, and less volume means that fewer people are interested in that stock.
Despite conventional thinking, breakouts or breakdowns don’t always require heavy volume, especially in this age of algorithms that know precisely what price levels will efficiently trigger significant movement.
The most common phrase is “Never short a dull market,” which fits just about right. Often, the heaviest volume bar forms at the peak of the move. It indicates the last of the chasers.
This is why heavy-volume hammers and shooting star candlesticks can form highly effective reversal signals. Volume analysis should be used in the context of the trading market conditions with other corroborating technical indicators.
In the Market: Volume Vs. Liquidity
When dealing with financial markets, liquidity is kept in mind before every position is closed or open.
If the market is volatile, but there are only a few buyers and sellers, closing your position in the market can be challenging. In such a situation, you can either stay at risk by being stuck in this losing position or go to multiple parties with different prices to fill your order.
Note
It is to be noted that market liquidity is flexible and works on a vigorous scale of high to low liquidity. A market’s position on the range depends on a mixture of factors such as the volume of traders and the time of day.
When the spread, the gap between the buying and selling price, widens, and the liquidity decreases for marketable security. This leads to inefficiencies for the buyers and sellers to find their prospective deals.
On the contrary, when the spread becomes thin, when the buying and selling price of stock come close enough to strike a deal, the liquidity is said to have increased.
Markets with suitable liquidity are stable and have a good investment environment for investors. Therefore, one can analyze assets based on their current liquidity in the market.
The stock volume insinuates the stock's activity in the market. That is, it shows the stock's performance in the financial market. Moreover, it also means that the interest in the stock and activities surrounding it are high.
Volume is sensitive to qualitative factors as well. So it can turn out to be positive and even negative depending on the talks about the stock in the market.
High volume indicates the number of times the share has been exchanged in the market. Therefore, volume tests the market activity of the stock.
Liquidity means the investor can easily get their money back upon selling the security they bought earlier. When there is a high volume in the market, it means there are more sellers and buyers in the market.
In a single trading session, the volumes remain high during the opening and closing of a session as intraday traders book and close their positions in a hurry before the session ends.
Therefore, trading volume is considered beneficial for short-term intraday traders.
This tool helps investors who use fundamental analysis in a trading session.
How Are Market Liquidity And Volume Related
When markets have high liquidity, it leads to low market volatility. On the other hand, when there is low liquidity, there will be more chances of prices getting destabilized.
Hence, markets with high liquidity are known to have more stable prices and a good environment for institutional investors.
Some highly liquid and low-volatility assets are bonds, blue-chip stocks, and others.
Volume and liquidity are both related in terms of market functioning. The stocks with higher volume are getting traded more easily and quickly than those with lower volume. Therefore, high trading volume indicates that the stock has high liquidity in the market.
Consequently, stocks with low volumes that trade slowly compared to high-volume stocks have less liquidity in the market.
Low liquidity also means the stock is not being traded in the market because no investor is interested in dealing with that stock. Hence, such securities have low volume and, therefore, low liquidity.
Market Preference
If we notice the trend carefully, the investors give more importance to the liquidity and its implications as it is easier to determine than the stock volume. Therefore, investors give more weightage to liquidity while making investment decisions.
Even though the understanding gained from the liquidity is easier to interpret, it is different from the volume. Volume is more complicated for investors to analyze., Thus, it is evaluated by brokers, portfolio managers, analysts, etc.
Conclusion
Since the depth and liquidity of a market depend on the entry decisions of all potential participants, each trader assesses them according to conjectures about entry by others.
If trade is equally costly across markets, this externality leads to trade concentration on one market.
To conclude the discussion over Volume versus Liquidity, no one factor is the most important in judging the securities in the market. Instead, more than one characteristic aids us in reaching a judgment concerning which security to invest in.
Volume and liquidity are just two important and more prominent factors that investors keep in mind while making investment decisions. Some others include risk associated with the security, return on it, period of investing, ongoing inflation rate, etc.
Thus, the factors you choose to determine which stock to invest in depend on your needs following your convenience.
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