Liquidity in financial markets refers to how quickly and at what cost an asset can be converted to cash without significantly impacting its price. For individual stocks, liquidity is primarily a function of average daily trading volume and the bid-ask spread — the difference between the price buyers will pay and sellers will accept. Highly liquid stocks (major index components like AAPL or MSFT) have millions of shares changing hands daily with spreads of a penny or less, allowing large orders to be filled without moving the price. Illiquid small-cap stocks may have wide spreads and thin order books, meaning a moderately sized buy order can push the price up substantially before being filled. Liquidity risk is the danger that you cannot exit a position at a reasonable price when you need to — it tends to be worst during market panics, precisely when investors most urgently want to sell.
