Many a time, investment involves buying an asset at a particular price in a base unit at a point in time, then exchanging it back to the base unit when it has increased in value. As simple as it may seem, this involves an awful lot of factors to consider. Apart from fundamental and technical analyses about the asset’s probable movements in most cases, factors outside the immediate scope of the asset are also put into consideration. Of these, one the most important, and perhaps the most underrated, is liquidity. What is liquidity? What makes it so important? Let’s find out, shall we?
Liquidity is the ease of exchanging a base unit for an asset, and exchanging the asset back to the base unit, without violently swinging the asset’s market price. This means a liquid asset is one you can easily buy and, most importantly, sell. It usually works with demand and supply. Chances are you can easily sell an asset that is in high demand and in lesser supply and vice versa. Apart from the intrinsic liquidity of an asset, the platform on which the investment or trade is taking place could play a huge role as well. This is usually an exchange. An exchange itself could have low liquidity, affecting the liquidity of your asset.
At this point, you can probably guess the importance of liquidity to your investment. It could be the determinant as to whether or not your investment will give you a good yield, and whether you can offset it fast enough to secure your profits. So you definitely want to go for liquid assets, in liquid markets. A very effective way to measure the liquidity of an asset is using a value called a bid-ask spread. It is the difference between the highest buy order and the lowest sell order of an asset. The higher the bid-ask spread, the lower the strength of the market liquidity.
In a nutshell, the difference between your investment going well and it going south is your consideration of the smaller things that make up the bigger picture. Liquidity is one of the more important things you need to put into perspective if you are looking to make well-informed investments and trades.
