Beginner’s Guide: Post 14
You know how to place your market, limit, and stop orders now – awesome! But placing the order is just the first step. Whether that order gets filled quickly and at the price you expect often comes down to these two buddies: Liquidity and Volume. They basically tell you how active and easy to trade a particular stock or asset is right now. Trying to trade something that’s not active or easy to trade… well, that’s often where beginners run into trouble.
First Up: What is Liquidity?
Think of Liquidity as how easily you can slip into or out of a trade without causing a big ruckus in the price.
- The Analogy: Imagine a huge, bustling city marketplace packed with buyers and sellers constantly making deals. If you want to buy or sell an apple there, it’s easy, right? There are tons of people willing to trade, and your single apple purchase won’t really change the going price. That’s High Liquidity.
- Now picture a tiny, quiet antique shop way out in the countryside with maybe one owner and one customer Browse. If you walk in wanting to sell a rare vase, it might be hard to find a buyer immediately, and your offer might significantly change what the owner thinks the vase is worth. That’s Low Liquidity.
So, in trading:
- High Liquidity = Lots of buyers and sellers actively participating. You can usually buy or sell quickly without your order drastically moving the price. Think popular stocks like Apple (AAPL) or Microsoft (MSFT) during market hours.
- Low Liquidity = Not many buyers or sellers around. It might be harder to get your order filled quickly, and a larger order could noticeably push the price up or down. Think obscure penny stocks or even some large stocks outside of main trading hours.
Next: What is Volume?
Volume is simpler. It’s just the total number of shares (or contracts, if you’re trading futures or options) that have actually been traded for that asset during a specific time period – like in the last minute, hour, or the entire day.
- What it Shows: Volume tells you how much activity or interest there is in that stock right now. High volume means lots of shares are changing hands – lots of trading is happening. Low volume means… well, not much is going on. It’s quiet.
- How to See It: Your trading platform almost always shows volume. Look below the main price chart – you’ll usually see a bar graph down there. Each bar represents the volume traded during that specific candle’s time period (e.g., the volume traded during that 5-minute candle). Taller bars mean higher volume.
Okay, So Why Do Liquidity and Volume Matter So Much to Us (Day Traders)?
This is where it gets practical. Trading stuff with good liquidity and decent volume makes your life easier and safer in several ways:
- Easier Entry and Exit: This is the big one. When there are lots of buyers and sellers (high liquidity), you can usually get your orders filled quickly and very close to the price you see quoted. No waiting around nervously, wondering if your order will ever fill.
- Tighter Spreads: Remember the ‘spread’ is the tiny difference between the highest price someone is willing to pay (the Bid) and the lowest price someone is willing to sell at (the Ask)? In liquid markets with lots of competition, this spread is usually very small (like a penny or two for active stocks). In illiquid markets, the spread can be much wider, meaning it costs you more just to get into and out of a trade.
- Reduced Slippage Risk: We talked about slippage with market orders, right? When there’s high liquidity and volume, there are more orders clustered around the current price, making it less likely that your market order will slip far from the price you expected. It can still happen, but the risk is generally lower.
- Confirmation of Moves: Seeing a big price move happen on high volume can give you more confidence that the move is genuine and has strength behind it. A price spike on virtually no volume is often less convincing and might fizzle out quickly.
The Dangers Lurking in Low Liquidity / Low Volume
Trading stocks or assets that don’t have much liquidity or volume can be seriously risky, especially for beginners. Here’s why:
- Nasty Slippage: Trying to use a market order in a low-volume stock? You might get filled at a terrible price, way different from what you saw.
- Getting Stuck! This is maybe the worst feeling. Imagine you own a stock, it starts dropping, and you want to sell… but there’s just nobody actively buying right now (low liquidity). You might have trouble getting out of your position quickly, forcing you to accept a much bigger loss than planned just to unload it. Scary stuff.
- Wider Spreads: As mentioned, the gap between buy and sell prices can be huge, meaning your trade has to move further in your favor just to break even, thanks to that built-in cost.
How Do You Check Liquidity and Volume?
It’s pretty straightforward:
- Look at the Volume Bars: Make it a habit! When you pull up a chart, glance down at those volume bars. Are they generally pretty high and consistent, or are they tiny and sporadic? Look for stocks that trade a decent number of shares per day (what’s “decent” varies, but often day traders look for stocks trading hundreds of thousands, if not millions, of shares daily).
- (Quick Mention) Level 2: Your platform’s Level 2 screen shows the current buy orders (bids) and sell orders (asks). In highly liquid stocks, you’ll see lots of orders stacked up. In illiquid ones, it might look pretty empty. This gives a real-time glimpse of liquidity, but just watching the volume bars is a great start.
- Stick to the Main Roads: Generally, major, well-known stocks (like those in the S&P 500), major currency pairs (like EUR/USD), and major futures contracts tend to have plenty of liquidity and volume during their main trading hours. Obscure penny stocks? Often not so much.
The Bottom Line: Stick to the Busy Markets (Especially at First!)
So, let’s wrap this up. Liquidity is all about how easily you can trade without messing up the price. Volume is about how much trading activity is actually happening. Both are super important for making sure you can get in and out of your trades smoothly and efficiently.
Here’s the key takeaway: As a beginner day trader, you generally want to focus on trading things that have plenty of liquidity and consistently decent volume. It reduces your risk of getting bad fills (slippage) or getting stuck in a trade. It just makes the mechanics of trading much smoother.
Make it a habit: whenever you look at a chart, take a second to check the volume. Is it active? Or is it a ghost town? Choose the busy streets, not the deserted alleys, especially while you’re learning!
What’s Next?
Okay, you understand how crucial volume is, and you know how to read those candlestick charts. Now we’re ready to start putting those chart-reading skills to work with one of the most fundamental approaches traders use: Technical Analysis. It sounds fancy, but the core idea is simple: using past price action (like those candles!) to try and figure out where the price might go next. And the first step is learning to spot key price levels on your chart.
Let’s discover how to find crucial buying and selling zones in Introduction to Technical Analysis: Finding Support & Resistance Levels
