While volatility is our lifeblood as tastylivers, liquidity is truly second to none in regards to its importance in trade selection. If an underlying instrument doesn’t offer highly liquid markets with lots of activity, then we simply aren’t interested in trading that instrument. Two of the primary indicators of liquidity are number of shares traded in the instrument and the width, or lack thereof, of the bid-ask spread.
Generally speaking, we like to see shares traded in the millions, and we like to see relatively tight bid-ask spreads. For some instruments, like the SPY, AAPL, or FB, this spread could be as little as a penny or two. For some higher priced stocks that are still highly liquid, like PCLN, the spreads could be much wider – like $0.50, or so. Very illiquid stocks typically have either very few shares traded during the day, wide bid-ask spreads, or both. Kellogg’s (K) and Chipotle (CMG) are examined as examples of less liquid underlying instruments.
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