Definition
Liquidity is how easily an asset can be bought or sold quickly, in the desired size, without moving its price much. A liquid market has many active buyers and sellers, narrow spreads and deep order books.
How it works
Several features signal liquidity: a narrow bid-ask spread, large quantities displayed near the best prices (depth), steady trading volume, and prices that recover quickly after a large order. Liquidity is not constant, since it varies by instrument, time of day and market conditions.
When liquidity is thin, orders of the same size cause larger price moves, spreads widen, and exits can take time or cost more. Stress events can dry up liquidity suddenly even in normally active markets, so volume that looks sufficient in calm periods may not be there when needed.
Formula / convention
Days to exit ≈ position size ÷ (participation rate × average daily volume)
Illustrative example
Illustrative: one holder owns 50,000 shares of a fictional stock that trades 1,000,000 shares a day, and another owns 50,000 shares of a fictional stock that trades 100,000 a day. The first position is 50,000 ÷ 1,000,000 = 5% of daily volume and the second is 50%. If each holder limits participation to 10% of daily volume, the second needs 50,000 ÷ (0.10 × 100,000) = 5 trading days to exit, while the first can finish within one day.
What to watch for
Volume and spread figures describe past or displayed conditions, and liquidity can vanish during stress or outside regular trading hours. Large holdings in thinly traded assets may be hard to exit at a quoted price.