Your ability to make money in the stock market is made up of many factors. One of the most important factors is how easily can you buy or sell the stock.
Liquidity, in the stock market, refers to how many buyers or sellers are interested in a particular stock. For example, you can count on finding a buyer or seller for IBM, Dell, General Electric and so on.
But what about Electic Prunes? Not familiar with that stock? I just made it up.
The point is there are thousands of stocks on various markets that may present huge opportunities, but lack access to or visibility in the investor community.
This is often the rap on so-called penny stocks (those stocks selling for around a $1 per share or less). If there are few buyers or sellers in the market for a particular stock it can be hard to buy or sell at the price you want.
The worse often happens when a stock's share price begins to drop rapidly and buyers are no where to be found when you need to sell.
How can you protect yourself from a liquidity crisis? In most cases, sticking with stocks listed on major exchanges offers enough protection. If a stock (or the stock market in the case of a flash crash) drops rapidly, you still may not get the sell price you want.
Another way is to examine the average trade volume of a stock. Almost all major quote sites will show you volume of trades. For example, Yahoo Finance offers interactive charts that detail the stock's price and volume.
If you see a stock that is trading under 100,000 shares per day, be careful - that's a thin market. IBM, for example, trades about 4.5 million shares per day.
A liquidity crunch can trap you in a stock with no buyers and that's a recipe for losing your investment.
