Booyah Breakdown: Liquidity

Same thing happens with stocks.

You have to sell your stock shares to a market-maker or your broker, who will then sell those shares to someone else.

Well-known stocks with large market capitalizations, like Procter & Gamble (PG Quote - Cramer on PG - Stock Picks), and News Corp. (NWS Quote - Cramer on NWS - Stock Picks) usually trade at a bid/ask spread of a fraction of a percent. However, less popular or smaller market-capitalization stocks may trade at bid/ask spreads of 1% or more.

That's why the bid/ask spread is often a good way to judge market liquidity, because the wider the bid/ask spread, the less liquid the market.

But because liquidity is determined by the availability of willing traders and investors, many will argue that liquidity is a signal of investor confidence. "If investors are not confident in the market and its viability, they'll pull their money out," says David Goldenberg, an associate professor of investments and derivatives at Rensselaer Polytechnic Institute's Lally School of Management and Technology. That means fewer people are trading and things become illiquid.

In addition, liquidity exists when investors are creditworthy. That's because people with good credit can get loans, and that means they have access to more money that can then be dumped into the market.

Which Way Are the Tides Flowing?

These days, the market is very liquid thanks to low interest rates and a respectable level of investor confidence. With that, tons of players are in the game and have created a classic supply-demand situation.

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