Liquidity: market float, average daily volume and turnover

What makes a share liquid?

Equity market liquidity is how easily you can buy or sell shares, in terms of both cost and timing. The explicit and implicit costs from the previous lesson vary with the size and timing of an order and with news that moves the price.

A common way to judge liquidity compares two numbers: how many shares are free to trade, and how many actually trade on a typical day.

Equity market liquiditycost and timing

• Trading costs Know the idea the spread and the implicit costs of the previous lesson
• Float and volume
  • Market float Memorize shares free to trade
  • Average daily volume Memorize shares per business day
  • Turnover ratio Memorize average daily volume ÷ market float
• Order book shape
  • Depth Memorize size of orders near the best prices
  • Breadth Memorize number of orders at nearby price levels
  • Resiliency Memorize speed back to a clearing price

How do you calculate market float?

Market float is the number of shares free to trade in the public market: shares outstanding minus restricted shares , or other shares not available for trading. It is a count of shares. (Some people use “float” for the market value of those shares. Here it means the count.)

$$\text{Market float} = \text{Shares outstanding} - \text{Restricted shares}$$

Weights that adjust an index for float are a Quantitative Methods topic (see market-cap and fundamental-weighted indexes).

What is average daily volume?

The average daily volume (ADV) is the average number of shares traded per business day over a period you choose, n days. It counts shares, not money.

$$\text{ADV} = \dfrac{\sum_{i=1}^{n} \text{Shares traded}_i}{n}$$

Exam tip There is no fixed window. A question will tell you the period (a week, a month). Use the number of business days in it.

What does the turnover ratio tell you?

The turnover ratio is ADV divided by market float: the share of the freely tradable shares that changes hands on a typical day.

$$\text{Turnover ratio} = \dfrac{\text{ADV}}{\text{Market float}}$$

Daily volume is usually a tiny fraction of the float, because listed companies have so many shares outstanding. A turnover ratio below 1% a day is normal.

How many days to sell a position?

Compare your position with ADV. If you may trade at most a set percentage of ADV each day (a participation limit ), divide the position, as a multiple of ADV, by that limit and round up to whole days. The result is the days to sell a position .

$$\text{Days} = \left\lceil \dfrac{\text{Position} \div \text{ADV}}{\text{Daily limit (\% of ADV)}} \right\rceil$$

A large stake in a small company can take weeks to sell without breaking the limit, and the longer the sale, the more the price can move (delay and opportunity costs).

Exam tip Always round up. 22.86 days means 22 full days are not enough.

Change the inputs and watch the ratio and the days to sell move.

Depth, breadth and resiliency

Beyond costs and turnover, liquidity has three more dimensions.

• Market depth is the size of orders posted at or very near the best bid and ask. Deep markets absorb many orders.
• Market breadth is the number of orders at different price levels just above and below the best bid and ask.
• Market resiliency is how quickly prices return to a stable market-clearing price (the price at which all buy and sell orders can be executed, with no excess demand or supply) after a shock.

Depth and breadth together describe how many orders sit in the book, how large they are and how spread out. With both, trades of manageable size fill quickly without moving the price much, and trading algorithms can split large orders without hurting the price.

A shock plays out in steps. News causes an initial price change, which depth and breadth can dampen. Then the price converges to a new clearing level. Orders nobody can see (orders with special conditions, blocks worked in pieces, computer-triggered trades) also affect the speed, and can cause sharp swings during the day.

Take two shares that both quote 30.00 / 30.02. In the first, 20,000 shares wait at each of the five price levels either side. In the second, 2,500 wait at each level. A 10,000-share market sell fills entirely at the best bid in the first share. In the second it fills across four price levels: the best bid and the three below it. Same spread, very different depth.