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What is Illiquid Stocks

21 Aug 2023

Investment in the stock market may be an ideal way to diversify your portfolio while growing your wealth. However, navigating the stock market may take a lot of work, particularly when learning about the illiquid stock market. Illiquid stocks are less readily traded than others and might be risky investments if you do not know what you're doing. As a result, you must understand the fundamentals of the illiquid stock market and the potential risks that come with it. 

Let's understand more about illiquid stocks. 

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What are Illiquid Stocks?

An illiquid stock is a security that can't be quickly turned into cash. Hence, this implies that it may be difficult to identify someone willing to purchase or sell the stock at a reasonable price, making trading difficult. As a result, illiquid stocks are less valuable than liquid stocks.

The major reason illiquid stocks are undesirable for investors is that they might provide several risks. For example, if you have to liquidate your shares immediately to meet an unexpected need, you may be unable to find a buyer at a reasonable price. As a result, it is of the utmost importance to exercise caution when investing in illiquid equities.

How Can You Identify Illiquid Stocks?

One way to identify illiquid stocks is by observing their daily trading volume. The trading volume on several financial websites or stock market applications displays the number of shares traded on one particular day. A stock with minimal daily trading volume can be deemed illiquid because there are insufficient buyers and sellers to sustain considerable price changes. 

Also, another way to identify illiquid stocks is by checking their wide bid-ask spread. 

An absence of current price movement or volatility indicates that a stock is illiquid. Stocks that have little movement in price over time may be deemed illiquid since there is inadequate trading activity to sustain major price fluctuations. 

The stock is likely illiquid if there is a substantial difference between the bid and asking prices.

If institutional investors lose interest in a stock, it indicates poor performance on rates of return.

Conclusion

Illiquid stocks have the potential to perform well in the long run. Similarly, there is risk connected with them. As a result, having a strategy in place for investing in illiquid equities is critical, based on the investor's risk tolerance and long-term objective. 

A wise investor will select illiquid stocks with high long-term growth potential. They will conduct the necessary research before investing in them and invest a tiny portion of their investment portfolio, the loss from which may be sustained.

 

Related Articles: Difference Between Margin Trading and Leverage | What is Evening Star Candlestick Pattern | Difference Between Margin Trading And Short Selling | How to Use Volume Trading in the Stock Market

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