I have learned the hard way that liquidity is of paramount importance when trading stocks. It is my belief that a lot of traders underestimate the role that liquidity or lack thereof can play on their trading and returns. I know I was one of them.
What is it?
First of all, let’s define what liquidity really is. The simplest definition is the ability to get in and out of a stock at the prevailing market price without actually affecting the price. This is never a problem with large cap stocks such as IBM, Microsoft, Google, and Apple. However, this can be a problem with many smaller cap stocks that trade less frequently.
I recently tried to sell some shares of a smaller company and the bid literally dropped 2% with my rather small order of just 2000 shares. It was my mistake for putting in a market order, but I wanted the trade to execute immediately so I could buy another stock right away. Unfortunately I had 2% less capital to trade than I thought initially.
What is Sufficient?
There is no magical level where liquidity is sufficient, but I would say any stock that trades over 500,000 shares per day is acceptable. I used to think that 200,000 was enough, but it isn’t. Such a stock would go up to 15 minutes during the day without a single trade taking place. During this time, even a nominal order can move the price significantly one way or the other.
If You Must
Sometimes there is no way to get around the liquidity problem if the stock in question is a can’t-miss in your opinion. In these cases, make sure to use limit orders. You might not get the stock or sell it at the exact time you want, but the potential for slippage is too great to put in a market order. I learned that waiting a little longer, even if it is a few days is worth it, rather than seeing the bid crushed when I put in my order.
Liquidity: Without it, You’re All Wet is an article from: 
