4 – M1L3 04 Liquidity V4

Market makers play an important role in keeping a stock market running smoothly. Imagine what would happen without market-makers? It would be harder to buy or sell stocks at a consistent price. As people start selling a stock, its price would start falling and vice versa. Formally, we say that a market maker provides liquidity. Liquidity is the property of a financial asset like a stock, to be bought or sold without causing sharp changes in its price. For instance, Apple stock sees a lot of day-to-day activity. So, we say that it is liquid. If you have a large number of Apple shares and you want to sell them, there’s a good chance you will get a consistent and predictable price for them. On the other hand, stocks that are relatively difficult to buy or sell are said to be illiquid. Penny stocks, for example, are typically very thinly traded. Consequently, buying or selling them may be difficult. Liquidity can also vary from market to market. Oh yes, the same stock can be bought or sold in different markets. HSBC is one such stock. It’s listed in both New York and Hong Kong. Let’s look at how its price changed during a month of trading. Each market maintains its own book of orders so the same stock can trade at different prices in different markets. The difference is usually small, as you can see, and any big changes permeate across markets pretty quickly. That being said, it’s possible to profit from market inefficiencies by simultaneously purchasing and selling an asset in different markets, thereby exploiting the differences in price. This idea is known as arbitrage.

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