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Market liquidity is a business or economics term that refers to the ability to quickly buy or sell a particular item without causing a significant movement in the price. The term is usually shortened to liquidity.
The essential characteristic of a liquid market is that there are ready and willing buyers and sellers at all times. An elegant definition of liquidity is also the probability that the next trade is executed at a price equal to the last one.
A market is considered deeply liquid if there are ready and willing buyers and sellers in large quantities. This is related to a deep market, where orders can not strongly influence prices.
The liquidity of a product can be measured as how often it's bought and sold. For stocks this is known as the volume of trades ([1]).
Often investments in liquid markets such as the stock exchange are considered to be more desirable than investments that are considered relatively illiquid, like real estate. This is because the forced sale or purchase of an item in an illiquid market may be at a disadvantageous price.
Speculators and market makers contribute to the liquidity of a market. One of the usual objections to a Tobin tax is precisely that it will discourage speculation on currencies, which will lessen the liquidity of foreign exchange markets, increasing their volatility. It is for this reason that market makers and professional traders are exempted in the UK from the 0.5% ad valorem stamp duty on share purchases.
The risk of illiquidity need not apply only to individual investments: whole portfolios are subject to liquidity risk. Financial institutions and asset managers that oversee portfolios are subject to what is called "structural" and "contingent" liquidity risk. Structural liquidity risk, sometimes called funding liquidity risk, is the risk associated with funding asset portfolios in the normal course of business. Contingent liquidity risk is the risk associated with finding additional funds or replacing maturing liabilities under potential, future stressed market conditions.
When a central bank tries to influence the liquidity (supply) of money, this process is known as open market operations.
In business lingo, merchants often have liquidation sales, in which inventories are sold at discount to raise cash.
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