Understanding How To Identify Liquid Stocks: Traders or investors who have been in the stock market business know that the main challenge lies in timing the share market. Individuals in this business try to identify the ways which can help in identifying stocks that have the ability to make money. Stocks having high liquidity are the ones capable to ensure quick profits.
Stock liquidity is used while analyzing which stocks to purchase. Liquidity means how easily an individual can turn an asset into cash. Assets that can be easily converted into cash are said to have higher liquidity. This is one main indicator of how tradeable a stock is.
In this article, we will dig deep into how an investor can ensure that the asset is a liquid stock. Apart from this, this article will give you insights on How To Identify Liquid Stocks And Trade Them.
Liquid Stocks – What are they?
Liquid stocks are the ones in which a trader can trade without significantly affecting the price of the stock. Traders can easily enter and exit these stocks. The charts of these stocks are much smoother in comparison to the ones that are illiquid. Traders can see the body on each one-minute candlestick chart. Most of the low-priced and penny stocks are illiquid.
Before investing your hard-earned in stock, it is of utmost importance to evaluate a particular stock from different angles. Apart from metrics like past growth rate, return potential, and risk, the stock’s liquidity should also be put into consideration. As an investor, it is imperative to understand the stock’s liquidity before taking an investment call. This is true when an investor has a shorter investment horizon.
Traders should avoid trading in illiquid stocks! This is because they are choppy, have high spreads, and they are difficult to get in and out of. At the time of analyzing illiquid stock charts, it is very difficult to see intraday chart patterns and support and resistance levels.
Why does liquidity matter at the time of purchasing stocks?
Some traders consider liquidity as the most important parameter while analyzing and buying stocks. Stock liquidity helps in determining how accessible an investment is. Most large-cap stocks are considered liquid stocks. Why do investors look for liquidity while buying shares? The main reason is to ensure certainty which can be evaluated with the help of the price spread.
The price spread is the difference between the market’s buy orders and sell orders. This indicates the difference between the price given by the buyer and the net price which the seller has received.
Liquid stocks have tight spreads between the prices. As a result, it ensures a high level of certainty in an asset price. On the other hand, illiquid stocks tend to have higher price spreads. Therefore, their price levels are quite uncertain.
How To Identify Liquid Stocks And How To Trade Them?
Liquidity in the stock increases when they are hot and volatile. At the same time, liquidity fades when they cool off. Just because a share is liquid today doesn’t mean it will be liquid tomorrow. The interest in that particular stock can be faded quickly. So, traders are required to think about how volume can fluctuate with time.
- Look for stocks in which the difference between the bid and ask price is less
This is the first step in identifying liquid stocks. Investors should always look for stocks having narrow bid-ask spreads. In other words, bid and ask price is required to have a small difference. If such a situation occurs, this will indicate that there are more buyers who are interested in purchasing the stocks at the price which is suitable to the sellers. Therefore, this situation indicates that stocks are liquid enough.
- Higher trading volume
Trading volume can also help in determining the stock’s liquidity. Higher trading volumes refer that a higher number of shares are being bought and sold. Higher trading volume is a positive sign. This is because it shows that the stock is in demand and it has a significant number of prospective buyers. Therefore, this means that the stock is liquid and traders or investors can take a call accordingly.
- Consider looking for stocks having a high float
A stock float refers to the total number of shares that are available for public investors. These shares can be bought or sold by public investors. It can be expressed as an absolute number (like 15 million shares) or sometimes it may be expressed as a percentage of the company’s total outstanding shares.
The higher trading volume during a high float exhibit that the higher number of available shares are traded at a high rate. Therefore, it means that the stock is highly liquid.
How can traders trade liquid stocks?
- Trading liquid stocks from a long-term perspective
Long-term investors are not required to be worried about liquidity. Why so? This is because these investors can hold the stocks for a longer time frame. These investors can afford to sit on the bid. This is because liquidity is not an issue. Long-term investors can sail through periods of illiquidity and wait for new buyers or sellers.
- Liquid stocks are necessary for short-term traders
The last pointer to consider when learning How To Identify Liquid Stocks And How To Trade Them is this –
For swing-trader, liquidity is of utmost importance. This is because of the shorter time frame of the trade. Since these traders are required to square off their position at the end of the day, they should always go for liquid stocks. Liquidity is a must for stop-loss orders.
Also Read: How To Book Profit In Trading And Investing? Things You Need To Know!
In Closing
Liquidity is an important indicator of analyzing the degree to which a particular stock is tradeable. If the stock is not liquid enough, it’s not worth trading it. It’s better to simply skip the trade if the stock is not liquid. Even if you think that the trade might work out, it will not be worth the risk. Eventually, you will be able to choose more ideal stock.
Trading in illiquid stocks is extremely risky. The price movements can be substantial and choppy, they have high spreads, and executions are quite challenging. The risk involved in trading illiquid securities sometimes overpowers the returns which are expected.
Once you gain enough experience in the stock market, you will understand if a particular stock is liquid or not. That concludes the article “How To Identify Liquid Stocks And Trade Them”, We hope you liked reading it. Happy Investing!
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