How liquid shares or stocks can be depends
The ability to buy and sell shares in a company is referred to as liquidity. For instance, if a trader wishes to buy some shares in a company like the National Australia Bank (NAB) it is a very simple matter to telephone the broker and the shares can be bought in seconds. Similarly, if a trader wishes to sell shares in NAB, the process is quick and simple ? telephone the broker (by the way, the trade is just as easily transacted via an internet broker) and the shares can be sold in seconds. NAB is referred to as a highly liquid share.
Compare this with an investment in a residential unit. It is not a simple matter to purchase a residential unit; it may take days, weeks, months to find the right unit. Once one is found the negotiation process may take days or weeks. Once agreement is reached the settlement will take around six weeks at least. Imagine now one wishes to sell a residential unit ? this process to can take many days, weeks, months or perhaps years. Of course one always has the choice to drop the price of the unit to a level where interest can be attracted quickly, and so speed the sale this way. A direct property investment is thus an illiquid investment; it cannot be bought and sold quickly like NAB shares.
There are shares on the share market though, that, like the residential unit, are illiquid. There is such a lack of interest in some of the shares on the share market that finding buyers for these shares is often very difficult. These shares can be contrasted with NAB shares; if one wishes to sell one’s NAB shares the process is quick and simple, there are always buyers, about. But for illiamid shares hovers may only be found if theshares are offered for sale at very low rates. Liquidity is the measure used in the share market for the ease with which a share can be bought and sold. A liquid share can be bought and sold readily in any normal market condition; an illiquid share, on the other hand, and like our residential unit, cannot be bought and sold quickly in normal market conditions.
Illiquidity introduces extra risks into trading. The primary rule of trading is to only trade shares that one can buy and sell readily. If one is left holding shares that one cannot sell, trading capital can be tied up indefinitely and a final, frustrated sale of the shares may result in substantial losses (because, like a residential unit that cannot be sold, an illiquid share could probably be sold if the price is dropped low enough ? and this is not good trading practice). The liquidity of a share varies with a couple of factors. The most obvious is market capitalisation. The larger is a company’s market capitalisation, then generally the better the liquidity of the company. Market capitalisation is a measure of the size of a company. It is measured by multiplying the number of shares on issue in a company by the share price of the company.
As at the time of writing of these notes, the market capitalisation of the National Australia Bank was:
(No. of shares on issue 1,550,303,000) multiplied by (market price of $28.55) Gives $44,261,150,650 We can compare this with a small market capitalisation company. We will leave this company unidentified, but shall name it “Tiny cap.”. (No. of shares on issue 83,150,470) multiplied by (market price of $0.02) Gives $1,663,009
Another reason that liquidity varies is the level of interest in trading the shares of a company. For instance, recent figures suggest that around 1 in 10 Australians own shares in Telstra. This is a very, very high level of interest and this is reflected in the ease with which Telstra shares can be bought and sold. A high level of interest equates to high liquidity. How does a trader assess the liquidity of a share, bearing in mind that one can reduce trading risks by only trading liquid shares? One way is to look at the volume of shares being transacted.
