Securities hold a considerable share of the financial market. They are interested in not only professional investors, but also novice traders who want to earn money on the stock exchange. The key to success is the ability to assess the reasonableness of investments correctly. The most crucial indicator determining the correctness of choice is the liquidity of assets.
Definition and factors of influence
What is meant by the liquidity of security? This is an opportunity to sell it at a market price in a short time. In other words, this is the demand for assets. Several parameters determine its level.
- Issuer stability. A well-known company with constant income, transparent financial policy and clear prospects will have many people who want to buy shares, which means more liquidity.
- Spread. The range of stock quotes for a particular instrument is inversely proportional to liquidity – the more in demand the asset, the lower the spread level.
- Trade turnover and the number of transactions. The number of transactions carried out and the amount by which they were concluded indicate the supply and demand for this trading instrument. The higher the volume, the faster you can sell the security.
- Volatility. Its effect on liquidity is similar to the spread – highly liquid assets usually have low volatility.
- Free float. A large percentage of free shares entails an increase in the number of transactions – liquidity is growing. But this rule only works for companies in demand on the market.
Securities liquidity indicators
Given the influence factors, the following liquidity indicators are distinguished:
- Width – spread level;
- Depth – the number of transactions at optimal prices;
- Speed of execution of the largest order in the market;
- Elasticity – the period necessary for the market to recover after the order is closed.
A good liquid market has a narrow spread on traded assets and sufficient depth for quick transactions. Their value is easily evaluated in a glass of prices. The active trader will have to take these parameters into account regularly, focusing on average data:
- In terms of trading volume during the day – the larger the turnover, the greater the chances of quick execution of the application;
- In the range between maximum and minimum prices – a low level makes assets in demand.
To control the volume, particular indicators are used, which are installed on the charts. Turnover data will be presented for the period used by the trader on the chart – for example, a day or five minutes. Based on these parameters, it is easy to conclude about the liquidity of assets.
Today you can find more than a dozen methods of analyzing the liquidity of securities. There are very simple graphical options and complex mathematical models. Based on factors affecting its level, in practice, there are two methods of assessment.
- Fundamental analysis. Based on a study of the issuing company, in particular, financial statements are examined in detail. It evaluates operational activities, solvency, market stability and development prospects.
- Quantitative analysis. This is where mathematical indicators come in — the spread, trading volumes and earnings per share (EPS), which is calculated as the ratio of net profit to be distributed to the number of shares in average annual terms.
Securities by their demand are divided into liquid and illiquid assets. In practice, two more subspecies are distinguished – conditionally liquid and slightly liquid. The type of market in which securities are traded plays a vital role in their liquidity. There are two main types of markets – exchange and over-the-counter.
The stock market is an organized platform (stock exchange) for open bidding with high competition. On it, the liquidity of securities is divided into high and low. The first includes blue chips – the most sought-after assets available on the exchange. The second – “junk shares”, whose issuers are not credible. To understand what type of securities belong to, it is enough to observe the main determining indicators – this is the spread and the turnover. Liquid securities are in demand, and orders are executed as quickly as possible. There are no applications for illiquid for various reasons, for example, the issuer’s low publicity or insufficient availability of real assets.
The OTC market is an area where trading rules are determined directly by counterparties. Intermediaries, searching for sellers and buyers, additional legal aspects for the legality of operations – all this takes time. The speed of transactions is significantly reduced, but investors have an interest in such assets. Typically, the bidding procedure is as follows:
- The seller company exposes a certain amount of shares at a certain price;
- Potential buyers get in touch to clarify the nuances of the transaction;
- Consulting agencies, which have an extensive base of counterparties, often act as intermediaries;
- After agreeing all the terms of the agreement, the participants draw up a transaction;
- Additional steps are possible to register the legality of the operation and transfer rights to regulatory authorities.
All these actions take a sufficient amount of time, and liquidity is speed. Therefore, the OTC market can hardly be called highly liquid.
Where highly liquid securities operate?
Analyzing the information, it is not difficult to conclude that the stock exchange will become the most convenient place for a quick turnover of assets. The obvious advantages of a large number of investors interested in profit, the high speed of transactions and market makers, excluding market chaos, allow securities to maintain liquidity at an attractive level.
The most liquid instruments for an investor are stocks and bonds. The volume of transactions on them is always large, and the spread and volatility are minimal. If you want to increase the liquidity of assets, it’s possible;
- Measures aimed at improving the financial performance of the organization and the growth of net profit;
- Coverage of news on production activities and successes of the company in the media;
- Regular publication in publicly available sources of timely financial statements and audit results;
- Reporting following international standards;
- Revision of investment policy, increase in the share of free shares in the market;
- Attracting investors with a large percentage of shares in the direct management of the organization;
- Use of stock exchanges for the sale of assets.
What is the result?
The main objective of the investor is the transformation of minimally invested money into assets with a high degree of profitability. For these purposes, the creation of a diversified portfolio with securities with different profit ratios is optimal. One of the determinants of choice will be the liquidity of securities – the ability to sell quickly without lowering the cost. And knowledge of the factors influencing it will help to conclude the most profitable deals.