8. Liquidity

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From the course by Indian School of Business

Trading Basics

305 оценки

Indian School of Business

Trading Basics

305 оценки

Course 1 of 5 in the Specialization Trading Strategies in Emerging Markets

The purpose of this course is to equip you with the knowledge required to comprehend the financial statements of a company and understand the various transactions that take place in the stock market so that you can replicate the strategies discovered by the extant academic literature. The first part of the course provides a brief introduction to financial statements and various common filings of firms. You will learn how to obtain information regarding a company's performance from them and use the information to build trading strategies. Next, you are taught basic asset pricing theories so that you will be able to calculate the expected returns of a stock or a portfolio. Finally, you will be introduced to the actual functioning of asset markets, type of players in the market, different types of orders and the efficient ways and opportune time to execute them, trading costs and ways of minimizing them, the concept of liquidity .etc. This knowledge is required to develop efficient algorithm to execute various trading strategies.

From the lesson

Basics of Market Microstructure

This module will provide a detailed introduction to the actual functioning of asset markets. The module will cover essential details such as type of players in the market, different type of orders and the efficient ways and opportune time to execute them, trading costs and ways of minimizing them, the concept of liquidity .etc. This is required to develop efficient algorithm to execute various trading strategies. After completing this module you will have a clear idea of different types of orders and which orders to use when.

1. Market and Limit Orders4:55

2. Limit Order Book7:28

3. More Limit Order Book6:49

4. Limit Price Placement4:56

5. Stop-Loss Orders5:11

6. Short-Selling3:59

7. Other Order Instructions7:54

8. Liquidity3:27

9. Transaction Costs7:22

10. Implicit Transaction Costs8:38

11. Implementation Shortfall5:49

Meet the Instructors

Ramabhadran Thirumalai
Assistant Professor
Indian School of Business

[MUSIC]

Until now you've looked at the different types of orders status may use including

additional instructions that may be included.

Next, we turn to understanding what liquidity is.

We will also look the various dimensions of liquidity.

This will help us better understand and

measure transaction costs that we incur while trading.

Let's first formally define what liquidity is.

It is the ability to trade quickly, in the quantity you want, and at a low cost.

It is one of the most important characteristics of an exchange.

There is a common saying that liquidity begets liquidity.

Regulators and exchanges aspire to have highly liquid market places as this

attracts traders in large numbers thereby increasing liquidity even more.

There are a number of dimensions of liquidity.

The first is immediacy.

It tells us how quickly can trades of a given size be executed at a given cost.

For example, say you want to buy 100 shares of a stock, and

do not want to pay more than $0.05 a share in transaction cost.

How long will it take for you to execute this order?

If you buy the 100 share at the cost of $0.05 a share, almost immediately

the market is extremely liquid as it provides a high level of immediacy.

A second dimension of liquidity is the width of the market.

This measures what the cost of trading a given size is.

What will it cost you to buy 100 shares?

This is usually measured by the bid-ask spread.

A narrow spread tells us that the transaction costs are low and

the market is very liquid.

On the other hand, wider spreads indicate that markets are illiquid.

A third dimension of liquidity is the depth of the market.

It measures the trade size that can be executed at a given cost, for

example if the bid ask spread is $0.05,

how many shares can be traded without changing the spread?

If there are a large number of shares to be bought and sold at the best bid and

ask prices, then you can trade a large order without moving prices much.

Here again we would prefer markets with high depth.

The fourth dimension of liquidity is resiliency.

It tells us how quickly prices revert to previous levels

after a large trade is executed.

For example, say an order for 10,000 shares moves prices by $0.50 and

the bid are spread wide as from $0.05 to $0.55.

If traders refill the order book quickly and bring down prices by $0.50 and

the bid-ask spread back to $0.05, then the market is said to be resilient.

A liquid market is where traders can execute large orders

with minimal price impact almost instantaneously.

Even when prices move on account of a large order,

markets are liquid if prices revert quickly.

Next time we will start discussing how to measure transaction cost and

the various benchmarks we use for it.

[MUSIC]

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