Liquidity at the London Stock Exchange

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Liquidity At The London Stock Exchange

As we have seen on other pages, there are different trading procedures at the London Stock Exchange. Liquidity is the main reason for these procedures.

In practice, although listed, many companies shares are not actively traded. This lack of activity can lead to higher costs (via the 'spread') or at times no market at all.

Liquidity is the ease at which individual shares can be traded and this has a very large influence on current prices. The liquidity will usually depend on

(i) the number of shares issued

(ii) the number of investors actively buying and selling and

(iii) the number of market makers who are prepared to quote a price.

As activity levels fall, prices become more volatile and therefore risk levels rise. As a general rule, the larger the company is, the more liquid it's shares will be.

Therefore, most FTSE 100 companies will be quoted and dealt in by virtually every broker. The amount that can be earned per trade is not necessarily high - this is where the competition is - but volumes can be very big.

Just in case it needs to be said, the biggest companies on the LSE are traded in massive quanitites. Literally millions of shares change hands in many of these companies every day. In terms of a monetary amount, that means that billions of pounds worth of stock market assets are traded daily. In those companies, liquidity is rarely a problem...

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In contrast, there are many FTSE Fledgling companies (those with the smallest of market capitalisations) that have only one or perhaps two market makers dealing in their shares. The spreads are large, which means more profit for the brokers and market makers, but they might only execute a few trades each week, so income is much lower.

Too Many Sellers Lowers The Price

As mentioned above, when there are few or no willing buyers it might be impossible to complete a trade. In these circumstances expect prices to be soft (lower) than might be quoted in the daily newspaper or online.

The price being quoted will be the last completed transaction, and if there are no other buyers and a person plans to sell into that 'market' the actual price of the next transaction might be several percent lower. In very small capitalised companies, a move of perhaps as much as ten percent of the price might be needed to complete a transaction!

Too Many Buyers Bring Profits!

In the opposite direction, I can recall back in the late 1990s watching BSkyB shares soar because of liquidity issues. The shares were rising more strongly than the market during a very strong market!

The reason as I later discovered was that only about 4% of the share capital was not held by big funds, institutions or majority shareholders. It meant that the rising price attracted interest and more and more investors chased fewer and fewer shares. The result? They rocketed!! When you next analyse a company, it's certainly something to look out for.

At the London Stock Exchange, in the quote driven market, shares are quoted in terms of price and also in terms of the number of shares dealt at that price. This is known as the NMS or Normal Market Size. Should the number of shares be greater than this number in a transaction, the price will often change - sometimes by a considerable margin.

Here is Investopedia.com's definition of liquidity.

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