When a company wishes to raise money for future growth and operating expenses, it can sell ownership shares to investors. A share of stock represents one unit of equity in the company that issued it. If a company issues 100 shares of stock, one share would represent a 1 percent ownership equity in the company. Most companies, however, typically issue millions of shares, which means that each share represents a very small equity percentage.
In financial terms, liquidity is the measure of how fast you can turn something into cash. For example, if you own a house, it can sometimes take many months or even years to sell it in order to turn your investment into cash. Thus, a house is not a liquid investment. A financial equity, by comparison, is very liquid. If you wish to sell shares of stock, you can usually sell them within a matter of minutes or even seconds.
In the stock market, liquidity is measured by trading volume. Trading volume is the number of shares that exchange hands each day. Some stocks are very popular and trade millions of shares per day, while those from lesser-known companies may only have a few hundred shares exchange hands in a day.
How Liquidity Affects Investors
Highly liquid stocks, such as Apple Computer, have trading volume that measures in the millions. If an equity is very liquid, you can usually buy or sell almost immediately at the price that is currently being quoted by your broker. If a stock has low trading volume, however, you may find that you have to pay a higher price in order to buy it quickly, or offer a lower price in order to sell it quickly.