Tuesday, June 2, 2015

liquidity = immediacy + resiliency

A Market (a particular exchange or an instrument) shows its true liquidity upon a Client-market-order. The other types of order are typically market-maker orders, which are (always?) limit orders.

#1 obvious sign of every illiquid product -- wide bid/ask.
#2 obvious sign -- tiny sizes of quotes (i.e. limit orders)

Now the defining features of a Liquid instrument. Look at EUR/USD...
1) Immediacy -- client order is immediately filled. It's necessary but not sufficient to have a tight bid/ask spread.

2) Resiliency -- low-impact. Minimal impact on equilibrium price even in the face of a large trade. Depth of market. If there are relatively large bid/ask volumes close to the best bid/ask, then impact will be low.

2a) strong demand -- large bids around mid-price
2b) firm and adequate supply -- large offers around mid-price

Even the largest instrument in the world -- EUR/USD can show a (temporary) drop in mid-price after a 100mio trade.

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New York (Time Square), NY, United States
http://www.linkedin.com/in/tanbin