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LIQUIDITY in the stock market is
confused with trading volumes. We
normally understand liquidity to mean stocks that have high trading volumes.
But that is not always true. So, what is liquidity? It refers to the ability to buy or sell shares quickly at or near
the current market price. Take Reliance Industries. Suppose there are buyers for one lakh
shares at prices ranging from Rs 499 to Rs 501 and there are sellers for 1.5
lakh shares at prices ranging from Rs 500.50 to Rs 502. The current price is Rs
500. What will happen if a mutual fund wants to buy 10 lakh shares? The price
should go up because the demand for the shares is more than the supply. But what if more sellers enter the
market, observing the additional demand for 10 lakh shares of Reliance? The
increased supply of shares will prevent the stock price from rising sharply. Suppose
the mutual fund buys 10 lakh shares at an average price of Rs 501. Note that
there is only a small price change due to sharp change in the demand for the
shares. This change in price is called the impact cost. Stocks with low impact
cost are said to be liquid. Now, take a situation where the stock
market is trending down. During such times, sellers outnumber buyers. Suppose
10 lakh shares of Reliance have already been traded. You now want to sell
10,000 shares at the market price of Rs 450. You may not be able to find buyers
at that price. Why? Because the market is trending down, buyers want to pay a
lower price. You cannot execute your order immediately at or near the current
price. The impact cost will be high. The stock is, hence, not liquid. The
volumes will yet be high. |
