What Does “Liquidity” Really Mean?

Tomorrow tickertank.com founder Nick Fenton will host a 3:00 PM CST chat session on TD Ameritrade’s trading platform, thinkorswim. Nick will cover trade selection regarding a few options strategies - Iron Condors, Butterflies, and Short Strangles. Be sure to catch the chat, as we’re sure you’ll learn a lot from Nick - he’s a seasoned pro!

One of the things Nick is sure to mention during his chat is liquidity. Liquidity, to most people, means the ability to sell something (like a house, car, or baseball card collection) for a fair price without a large delay in “execution”. In the market, liquidity includes this definition, but also involves the amount you lose when you enter a trade.

It’s common to see new traders, and even experienced traders, hear a tip on a new company, or catch an article online that sparks a trade idea. This isn’t a bad thing, but less-known (and less-traded) stocks have wider bid-ask spreads, which means you’re paying a higher price to buy, and receiving a lower price when you sell, than the real value of the shares. This is especially true in the options market, where low volume and wide spreads can lead to differences of $100’s of dollars per trade. 

How much do you lose to low liquidity? Well, if the bid/ask spread on an option contract is $1.30/$1.70, and you purchase the option, you’re paying $170 per contract for an option with a real value of $150 (the average of the bid/ask spread). This is $20 per contract you’re losing - a simple 5-contract trade pushes the “loss” to $100!

This isn’t money you want to leave on the table! Catch Nick’s chat tomorrow, and be sure to listen carefully for his full explanation on how paying attention to liquidity can save your trading life! 

Meet Nick here: http://www.tickertank.com/General-Information/meet-nick-fenton

(Source: tickertank.com)