Liquidity

Liquidity in the marketplace is a justification you hear about a number of behaviors that might not otherwise be justifiable. For example, someone buys a stock hoping or thinking it will go up, and then that stock is borrowed by a short seller who sells it trying to drive it down, it is OK because it adds liquidity to the market. Of course then there are the high frequency traders who have computers make trades that net very small profits individually but because of the volume they make a lot of money. This has nothing to do with investing since most of the action is computer driven based on pre programmed scenarios. However, they add liquidity to the market.

What exactly is the value of this liquidity? Well, it is nice to know that if you want to buy or sell just about any stock, your order can be executed any instantly when the limit you place is reached. However, is that really that important? Generally you would think publicly traded stocks would reach price points in a marketplace without the need for additional liquidity.

Recently we have seen France and Germany come out against short selling. I have discussed short selling before and no matter how I look at it, it seems designed to provide Wall Street insiders a way to gamble and manipulate the market. Now, it is a simple math problem. Increase the number of shares you can sell without increasing the total number of shares will correspondingly increase supply and unless demand already exceeded supply it will drive a price down, exactly what a short seller desires. Now yes, at some point the short seller will cover his short and that will create a sort of artificial demand, but why is this practice anything other than manipulation? Some short sellers have argued that they help to expose weak companies. Maybe they do, but what they then accomplish is to drive these companies down, below where a "normal" market would price them. In the scenario where the short sellers smell blood in the water as the price drops, real investors sell (often losing money) and analysts and lenders lose confidence in the company, often over something that without the short sellers wouldn't even have caused a ripple in the stock price. They love to exploit every possible way to drive prices down and some have become influential enough to be the cause of a dip.

And it leads to greater liquidity?