What is Liquidity risk?
The risk that when you want to sell an investment, there will be no one around who wants to pay what you believe is a fair price for it.
How this risk plays out in the real world
Following are articles that concern the issue of liquidity and not a specific corporation’s stock that is difficult to sell.
Sept 13, 2017: Bitcoin slides on ‘fraud’ warning from JPMorgan’s Dimon
Oct 17, 2014: Twitpic fails to find a buyer, will shut down
Sep 06, 2014: The Bond Bubble Will Pop, It’s Just a Matter of Time
Connection to other risks
This risk is connected with Systemic risk because when a financial system begins crashing, when investors are overcome with fear, they will rush to sell what they hold. With others doing the same thing, there’s a good chance that there will not be nearly as many buyers ready to absorb the quantity of shares being offered.
Read the glossary definition of Liquidity risk.
How investors can manage Liquidity risk
- Don’t buy penny stocks, tiny companies whose shares trade hands among investors infrequently.
- In general don’t make an investment before confirming that there is an active market of buyers and sellers for it. It is that market that you will one day sell the investment into when you no longer want to own it.
A final word
Investors don’t set out to purchase investments that will be difficult to sell. During the course of their ownership an event may happen which causes the investment community to change its views. For example, Superstorm Sandy flooded homes near the coast from New Jersey to New York’s Long Island. Over night, those “flood homes” became impossible to sell for any where near the value they would have fetched before the storm.