What are Illiquid Stocks? | Espresso

What do you mean by Illiquid Stocks?

Illiquid stocks are the ones that will not easily liquidate your money and cannot be readily sold or exchanged for cash without a significant loss in value. Simply put, illiquid stocks contrast with liquid stocks in the stock market. For an organisation, for example, illiquidity means that a business doesn’t have the required finances to take care of its debts.

Published on 24 January 2022

This, however, doesn’t mean that the organisation is devoid of assets. Pieces of machinery, capital assets like real estate properties and factories have a high value. However, they cannot be sold out easily when there’s a cash requirement or liquidity.

To get the needed funds during tough times, a business might have to sell off such illiquid assets to keep away from getting insolvent or financial distress. Also, if done practically, a business can even dispose of an illiquid stock at a price much below its reasonable market rate. Such sales are often considered as a distress sale or a fire sale.
Also Read: Stock Market & How to Invest in It?

What are Illiquid Stocks?

If you have no idea about what are illiquid assets, here is a simple definition for the same; illiquid stocks refer to generally high-risk assets that can’t be easily exchanged or sold for money without experiencing a loss in value. These are quite hard to sell due to the cost, shortage of available buyers, low trading activities, and so on.

However, illiquid assets are of high value and are usually high in price. Hence, finding the right buyer is always challenging for the investors because of the comparatively inadequate trading value of the illiquid stocks. And this lack of buyers impacts the level of inconsistencies between the selling price and the bidding price; the buyer submits that. This discrepancy leads to larger bid-sell prices. As a result, the holders of illiquid stocks can experience losses because of the shortage of depth of the market (DOM) and available buyers. Especially when investors are looking forward to selling an illiquid asset quickly, they are less likely to find a buyer.

What are Illiquid Investments? - A Few Examples

  • Common examples of illiquid stocks or assets include real estate properties like houses. Cars, collectables, a few types of debt instruments, and private company interests are also considered illiquid stocks in the stock market. Additionally, antique art pieces like paintings, watches, and limited-edition collectables are also termed illiquid assets.
  • Over-the-counter (OTC) stocks in the stock market have less liquidity than those listed on a strong exchange. Although these stocks have value, the stock market has fewer buyers for these than liquid assets. On the contrary, stocks like ETFs, mutual funds, listed commodities, and bonds fall under the liquid assets category and can be sold out instantly during normal stock market hours, at fair market values.
  • Again, trading in the stock markets that are executed post the regular business timings may result in illiquidity. This is because several potential buyers might not remain active at those
  • Lastly, as per different influences of the external market, the liquidity of stocks or assets may change over some time.

How to Identify Illiquid Stocks?

Here are a few significant pointers of certain illiquid stocks that cannot be easily sold or exchanged for a sum of amount in the stock markets. Hence, while identifying illiquid stocks in the stock market, analyse the market well by keeping these below-listed pointers in mind:

  • Gauge the sign of low-performing stocks with respect to returns by identifying the investors showing minimal or no interest in the stocks.
  • If the stock is attaining a lower value on a regular basis.
  • If the stock doesn’t have sufficient trading value.
  • If there is a huge difference in the asking price and the bid price of a certain stock.

Usually, illiquid assets have minimal trading volumes. Hence, these can’t be sold off immediately. Even if the investor tries to make the sale in haste, they might have to go through a considerable loss in the price.

Conclusion

Now that you are aware of what illiquid means, it will be easier for you to differentiate between a liquid asset and an illiquid asset in the stock market. Remember that illiquid stocks pose a higher risk to the investors since these are difficult to sell. While trading, therefore, always make wise choices that are also allied with your financial goals.
Also Read: Difference Between Stock Investing & Trading

Chandresh Khona
Team Espresso

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