Booyah Breakdown: Liquidity

Demand for stocks is up, so you've got a ton of buyers waiting in the wings to take your shares off your broker's hands when you sell them. That means many of the bid/ask spreads are small, and your broker won't hesitate to unload your shares.

"Demand is high, supply is low and, as a result, prices rise," according to Jacob Bernstein, author of 30 Days to Trading Mastery. "But that's a two-edged sword. Should investor sentiment change, the situation could reverse dramatically."

So now you can understand why the pundits keep saying liquidity is a big reason for the market's current run. Investors have money to invest. That increases demand and pushes prices up.

But if something happens that makes them nervous -- i.e. geopolitics, Federal Reserve rate hikes, etc. -- and they'll start pulling money out of the market, the liquidity will fall and trading will become much more difficult. If it's hard to make a trade, your broker might have to charge you a higher transaction cost because he may be holding the shares for longer than he wants.

That means it's important to keep liquidity at consistent levels. Unfortunately, much of this falls on the Fed and its ability to keep interest rates and employment at stable levels.

So here's to liquidity -- in the market and in a chilled martini glass.

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