There are two types of assets on the markets, which can be separated according to their ability to be sold without significant losses. Illiquid stocks, currencies or other financial instruments are hard to be traded as there is an insufficient number of those who want to purchase them.
Illiquidity and Assets’ Price
How does illiquidity affect the price of the assets? First of all, traders should know that illiquid assets are hard to be sold. It means that there is a low demand on them. This may lead to price cuts. Especially on the stock market.
How to explain this phenomenon? You a person has an asset that is difficult to sell, he or she needs to reduce the cost of this asset to get rid of it.
Illiquidity leads to larger spreads as compared to other financial instruments. If we compare EUR/USD with some exotic currency pairs, we can make a conclusion, that the Eurozone’s money is more liquid as it has a tighter spread.
Let’s sum up all this information:
- Illiquidity is a state of an asset when it is hard to sell it.
- An illiquid financial asset has wider spreads and lower volumes of trading.
- The volatility of such instruments is higher.
Examples of Illiquid and Liquid Assets
There are plenty of examples of illiquid assets in the world even if we do not speak about the financial markets. Houses, luxury cars, antiques, pieces of art (some of) may have lower demand in some periods of time because of economic conditions and their costs.
OTC stocks may also have low liquidity when they are listed on unknown exchanges. The reason here is easy to understand. Small exchanges have a low volume of buyers and even if those stocks have inherent value, they will not have a great demand on such marketplaces.
Forex currencies, shares of the famous and known companies, precious metals, commodities (especially oil and gas) are highly liquid assets as they are always in demand. International commercial activity is impossible without Forex exchange as a buyer needs local currency to purchase goods in a particular country. Oil and gas are used everywhere and have a high industrial utility.
Major exchanges guarantee that any listed asset will have higher liquidity because of the greater number of traders and investors. The price of liquid instruments is reasonably higher, which is explained by the higher interest for them.