The Importance of Depth (Volume)

Liquidity and Market Depth

Liquidity is perhaps one of the most important elements in gauging opportunities in a market. At its core, liquidity is the collective expression of traders' opinions on the market.

Like any other market, these opinions are represented in a futures market either as existing positions held by traders, known in futures as open interest, or as buy or sell orders communicated to the rest of the market but yet to be executed.

The size and price of these orders may vary considerably, but the key element to consider is that the more opinions expressed in the market, the more liquid the market is. 

Why is liquidity such an important element of market opportunity?

The reason is that the more participants there are, the more expressions of opinion on the market, the greater the likelihood that a single trader, like yourself, will encounter another with an opposing viewpoint that results in you both agreeing on a quantity and price to trade.

Another aspect to market liquidity is the ability to quickly check whether there is enough potential volume to suit their trading strategy. For example, an asset manager entering a new position with a large quantity of contracts would want to see a deep liquid market. A deep market allows them to execute a large order efficiently, while not causing significant price movements. The result is a more efficient execution, which reduces the trade impact costs of the transaction.

Summary

Understanding liquidity in a market is a critical consideration for traders before jumping into a trade. Futures markets offer deep liquid markets that let traders express their opinions in a tremendously efficient way.