What is liquidity?

Liquidity describes how quickly and easily a particular asset can be bought or sold without the need for buyers and sellers to compromise on price.

If a market is being traded regularly then it is said to be liquid, or to have high liquidity. This is because the volume of buyers and sellers in the market creates a free flow of trade, as there’s always someone willing to take the other side of a given position.

In a liquid market, a seller will quickly find a buyer without having to cut the price of the asset to make it attractive. And conversely a buyer won’t have to pay an increased amount to secure the asset they want.

If there are only a few buyers and sellers in the market, trading infrequently, it is said to be illiquid, or to have low liquidity.

How does liquidity affect spread bettors?

An asset’s liquidity is a key factor that determines a spread betting provider’s spread.

In general, the more liquid the asset, the tighter the spread

High liquidity means there are large numbers of orders to buy and sell in the underlying market. This increases the probability that the highest price any buyer is prepared to pay and the lowest price any seller is happy to accept will move closer together. In other words, the spread will normally tighten.

As spread betting providers derive their prices from those in the underlying market, a lower bid-offer spread here will usually translate into lower spreads offered on the platform.

Providers’ spreads can narrow even further due to the fact that it’s easier for them to hedge in a liquid market. Because their hedging costs will be lower, they can reflect this as a lower fee for their service in the spread charged to clients.

The most liquid and illiquid markets

Some of the tightest spreads are found in forex pairs. Forex is considered the most liquid asset in the world due to the high volume and frequency with which it’s traded. So you’ll usually see very narrow bid-offer spreads for major currency pairs such as EUR/USD, GBP/USD or USD/JPY. 

On the other hand, spreads for less liquid assets, such as small-cap stocks (generally a company with a market capitalisation of below £75 million), will tend to be significantly wider.

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