Wednesday wisdom nuggets brought to you by
This Wednesday we learn about liquidity. What does it mean for an investment
to be liquid? Or illiquid? By definition, liquidity is
how quickly an investment can be converted into cash without significantly impacting its price.
Investments with high liquidity are easier to sell and can be sold without a significant difference
in their price. While illiquid assets are difficult to sell and when they are finally sold;
they are sold at a larger difference in price. For example, Jane and Peter both run into an
emergency and need quick cash. Jane decides to sell her Stocks holding, while Peter attempts to
sell his car. Jane manages to sell the Stocks and receive the cash into her account in three days.
On the other hand, Peter realises it may take him months to find a buyer and ends
up selling the car at a discount to obtain a quick purchase. Janes stocks were relatively
more liquid as they could be converted into cash at a faster rate and the difference between the
price of what she bought the Stocks for and what she sold the Stocks was smaller than the
difference in the prices of Peters the car. Different investments fall along the spectrum
of liquidity; with real estate and fine art considered relatively illiquid assets,
and equities, bank deposits and of course cash itself; falling higher up on the liquid scale.
A market may also be termed as liquid or illiquid depending on the extent to which
the assets within that market can be turned into cash without a significant change in their price.
If the Stocks in the Stock market, have a high volume of trade
that is not dominated by sellers only, it may be termed as a liquid market.
Although the Stock market is among the most liquid markets, not all stocks are created equal;
some shares trade more actively than others on the Exchange. One way to gage the level of liquidity
of a share is to look at the volume traded. You may view the daily volume traded for all
shares on the Nairobi Securities Exchange on the AIB DigiTrader App or Online platform.
For example, on October 12th 2020 one hundred and thirty-four thousand, six hundred shares
of Cooperative Bank were traded, but this is modest compared to the three million,
one hundred and forty thousand Safaricom shares that were traded on that day; making the share
one of the Top movers of the day. If this is the general trend, it implies that Safaricom shares
are more liquid than Cooperative Bank shares. Another means to determine stock liquidity is
the difference between what the highest buyer is willing to pay versus the lowest price a
seller is willing to accept for that particular stock. A large difference implies illiquidity.
The liquidity of a stock or any investment for that matter is important to consider as
it determines how quickly and efficiently you would be able to turn that investment
into cash if the need arose. A lower level of liquidity implies a higher risk,
as an investor would find it difficult to off-load an asset if for example its value is dropping
or a personal emergency requires speedy cash. Stay tuned for our next Wednesday wisdom nugget!