Thursday, June 9, 2011

Why Liquidity Matters

It is so obvious why liquidity matters when it comes to performance of value investment strategies. I'm a little embarrassed not being able to articulate it in my previous post.

Liquidity generally reflects popularity of a stock. Popularity means that a lot of investors pay attention to the stock. There is an saying in the world of computer geeks that "Given enough eyeballs, all bugs are shallow". Similarly, all pricing errors are shallow given a lot investors are watching it. The less pricing error, the less profit left for value investors. Thus the inverse relation between liquidity and performance.

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