National Commodity Futures Examination (NCFE) Series 3 Practice Exam

Liquidity is about how easily you can buy or sell a security without moving its price much. In a liquid market, you can enter or exit quickly and at a price close to the last traded price, with only a small price impact and a tight bid-ask spread. That makes the statement describing quick and efficient entry or exit at a price near the last traded price the best description. If only a few traders participate, the market becomes illiquid because there isn’t enough depth to absorb trades without changing the price. If prices are posted only once per day, execution is slow and uncertain, which isn’t a feature of liquidity. High transaction costs deter trading and reduce turnover, also lowering liquidity. In short, liquidity means trades can be executed smoothly and near current prices.