An introduction to the reasons why some stocks are more easily traded than others.
Suppose you purchase something at ₹500 crores, and then you find that there are not many who want to buy it when you’re trying to sell. You cut down on your price and you start losing potential profit.
This is where market liquidity comes into play. Picking a stock is only part of the job: you must be able to enter or exit without significantly affecting its price.
The liquidity of Nifty 50 stocks compared to small-cap stocks and intraday trading opportunities plays a crucial role.
What Is Stock Market Liquidity?
Liquid stock market: the ability to buy or sell a stock without appreciably changing its market price. Low-liquidity stocks can be more difficult and expensive to buy/sell, while high-liquidity stocks typically have more bid-ask activity and tighter bid-ask spreads.
What Is Market Liquidity?
Liquidity is the ease of selling an asset at the market price without causing a large price movement. It relies on the presence of buyers, sellers, and buy/sell orders. Lack of liquidity may raise trading costs, says NSE.
The number of orders on a popular large cap stock might be high and the number of buyers on a small cap stock might be lower when you are taking your money out of the stock.
The main features of the liquidity of the market are:
- Frequent trading and trading.
- Tight spreads and good orderbook.
- Reduces price impact and buy/sell taker risks.
A liquid stock is not a good investment nor is it always safe. It refers to the simplicity with which you can exchange it.
How to Profit from the Stock Market
In the electronic trading system called NSE, eligible orders are matched based on its trading rules. Take a look at the following simplified order book:The highest bid is ₹499.90; the lowest ask is ₹500.00.
| Bid Price | Bid Quantity | Ask Price | Ask Quantity |
| ₹499.90 | 2,000 | ₹500.00 | 2,500 |
| ₹499.80 | 1,500 | ₹500.10 | 1,800 |
| ₹499.70 | 2,000 | ₹500.20 | 1,200 |
Bid-ask spread = ₹500.00 − ₹499.90 = ₹0.10
A small margin means competition in pricing. However, a large “sell order” could fill the best bid and thus sell on the basis of lower prices. Traders should not only look at the last price, but the market depth as well.
High Liquidity vs Low Liquidity
| Factor | High Liquidity | Low Liquidity |
| Risk of liquidity build-up / liquidity risk | Generally lower under normal conditions | Generally higher, especially during market stress |
| Buyers and sellers | More active; deeper market | Fewer active participants; thinner market |
| Bid-ask spread | Usually very small / tight | Usually larger / wide |
| Execution | Usually easier and faster | May be delayed, partial, or executed at a worse price |
| Price impact | Typically lower for a comparable order | Typically higher; small orders can move prices |
| Liquidity-related transaction costs | Generally lower | Generally higher |
| Volume changes | Often higher trading volume; volume can still be volatile | Often lower trading volume; price volatility tends to be higher |
Why Is It Bad If There Is Low Liquidity?
Suppose you purchase at ₹100, given that the chart appears bullish. Suppose you buy at ₹100 as the chart is bullish. On exiting, the best buyer can offer you only ₹98.50. Even if the last traded price is not far from ₹100, you may end up with lesser than what you expected.
A good chart pattern is not sufficient if the market’s not ready for the order at a decent price.
Determine the Measures of Stock Liquidity
Use 5 indicators to assess liquidity:
- Volume of trading: See how many shares were trading during a session. Use multiple days rather than a single outlier.
- Bid-ask spread: Take the highest bid price and subtract it from the lowest ask price. The narrower the spread, the less friction there will be with trading at the moment.
- Market depth: Look at the quantity on different price levels on both the buy and sell side. Orders can be cancelled before execution on the displayed orders.
- Trading turnover: Look at the amount of trading, not just the number of shares being traded. Trading 100,000 shares at ₹20 represents a different value from 100,000 shares at ₹2,000.
- Impact cost: This is the cost disadvantage of placing an order versus a theoretical cost. NSE utilises it as a useful measure of liquidity.
A Straightforward Liquidity Check List
Prior to making a trade, review recent volume and turnover, compare spreads, check market depth, check volumes of orders against typical volume and re-evaluate during periods of volatility and major news.
Let’s Look at a Real-World Trading Example Today to See How Liquidity Can Influence Your Profit
Today we will look at a trading example to see how liquidity can impact your profit.
Assume that there are two stocks that seem to have two possible price moves of ₹2 and you wish to buy 1,000 shares.
The number of details traded in each trade between Stock A and Stock B.
| Factor | Stock A | Stock B |
| Best bid | ₹99.90 | ₹99.00 |
| Best ask | ₹100.00 | ₹100.00 |
| Bid-ask spread | ₹0.10 | ₹1.00 |
| Shares purchased | 1,000 | 1,000 |
| Cost of quoted spread vs best bid | ₹100 | ₹1,000 |
Spread cost comparison does not factor in brokerage, taxes, other fees and changes in price. The greater the spread of stock B, the more potential profits that can be eaten up. Orders that fall short of the best price quantity may be more expensive depending on the size of the order.
Market Liquidity Importance to Different Traders
The type of trader and why it matters to their liquidity.
| Type of Trader | Why Liquidity Matters |
| Intraday trader | Helps manage entry and exit, reduces execution delays, and lowers transaction costs |
| Swing trader | Makes it easier to adjust or close positions when the trade thesis changes |
| Long-term investor | Helps smooth out the process of buying or selling without significantly affecting the price |
| Options trader | Affects option bid-ask spreads, implied volatility, and execution quality |
| Large-order trader | Market depth and price impact are critical because large orders can move the price |
Not every option contract is liquid; a liquid underlying stock does not imply that an option contract will be liquid. Look at its activity, expiry, spread, and strike. The high-volume breakouts require confirmation from some price action and market conditions.
Common Liquidity Errors and Tricks of the Trade
Five Mistakes to Avoid
- Stock selection based solely on price: Low priced does not necessarily mean safe or liquid.
- Ignoring the spread: A wide spread can diminish returns prior to a price action which is in your favour.
- Pursuing highs: These can be news, speculations or short-term interest.
- Guaranteed stop loss price: Quick moves can result in trades at a different price.
- Lack of appreciation for volatility: The depth of the market can shift rapidly, even within more active stocks.
SEBI cautions about low liquidity conditions leading to partial or failure to execute, or to execute at unexpected prices.
Practical Tips
- Look at session to session liquidity and consider spreads and size of orders.
- Think of limiting orders for price control, but take into account that these orders may not be executed.
- Do not focus capital in low volume stocks, and make entry/exit decisions, position size, and risk decisions plans.
The psychological aspect of trading is important: If a position turns adverse, you might feel a need to pull out of it right away. A lack of buyers can exacerbate the emotional aspect and the problem of liquidity. Make an exit plan before making an entry plan.
Learn Liquidity Analysis with Ruchir Gupta Trading Academy
In this section, you will learn Liquidity analysis with Ruchir Gupta Trading Academy.
Liquidity analysis is a combination of order books, price action and risk management.
Learners can learn intraday trading, options trading and technical analysis at Ruchir Gupta Trading Academy.
Before trading, ask:
- Is the stock actively traded?
- Does the spread make sense?
- Does my order have minimal impact on the price?
- Is the set up worth the risk?
- Have I thought through my entry, exit and position size?
Think about taking a stock market course from Ruchir Gupta and check out how the academy offers training, live learning and mentorship opportunities. No course is foolproof and designed to make money; just designed to enhance knowledge and discipline.
Conclusion: See Beyond the Stock Price
Market liquidity influences the execution of trades, execution costs, and position management. After you have made a trade:
- Check Trading Volume and Turnover.
- Analyze bid-ask spreads and market depth.
- Ensure balance between the size of the order and the risk profile with available liquidity.
Visit Ruchir Gupta Trading Academy and enhance your liquidity, technical analysis, intraday trading and options knowledge. Think of good habits, not fast money.
