Liquidity is an aspect of the market that typically shows how difficult it is to convert an asset or commodity into cash. All assets are traded against the dollar, but in crypto markets, you will often see digital currencies paired against other cryptocurrencies. In the context of TA, liquidity can also refer to zones of supply or demand where orders are already placed.
Markets (or trading pairs) that are liquid can convert assets instantly without drastically affecting prices.
On the other hand, illiquid markets cannot convert assets into cash all at once, since there is not enough volume located at one price level - which causes slippage. Even when one does execute a sell or buy order, the asset’s price will move drastically as a result of illiquidity.
For a certain price level to be liquid, the market spread between buyers (bids) and sellers (asks) must be kept to a minimum. The larger the spread the more illiquid the market is. This spread can be unnoticeably small or as large as a few percentages.
Liquidity is incredibly important because it allows us to quickly get in and out of an investment without any additional losses or delays. Keep in mind that liquidity gets more important as your portfolio increases, since your positions will require more liquidity to be properly executed.
In the next lesson, we will cover volume to assess the importance of liquidity in TA.
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