In the context of trading, what does 'liquidity' refer to?

In trading, liquidity refers to the speed at which an asset can be bought or sold in the market without causing a significant impact on its price. An asset is considered liquid if it can be quickly exchanged for cash without a large price discount. This concept is crucial for traders because high liquidity allows them to enter and exit positions rapidly, which is especially important in fast-moving markets or during times of volatility.

Assets that exhibit high liquidity, such as major stocks or currencies, typically have many buyers and sellers, facilitating quicker transactions. Conversely, assets with low liquidity, such as some small-cap stocks or certain commodities, may take longer to sell and may require discounting the price to attract a buyer. By understanding liquidity, traders can make informed decisions about how and when to execute their trades while minimizing potential losses due to unfavorable price movements during the transaction process.