What is an Active Market?
"Active market" is a loosely-defined phrase referring to a market with a notably high level of trading. This type of market has some distinct characteristics. This in turn brings specific risks and opportunities to investors.
There are two different meaning for the phrase "active market." One is for the market in a particular stock or other financial product. The other is for an entire market such as the US stock market.
An active market will normally be fairly liquid. This is a measure of how easy it is to buy or sell a product without causing a change in its price. As a general rule, larger investors prefer a liquid market as it is easier to quickly sell off assets if, for example, a customer wants to cash in their investment.
In a market which is not particularly liquid, suddenly selling assets can cause the market price to fall, which may limit or even undo the benefits of selling at that particular moment. Similarly, trying to buy a stock in an illiquid market can drive the price up beyond that which the buyer had counted on paying. The presence of an active market is particularly welcome for large institutional investors, as they deal in greater volumes and thus present a greater risk of their transactions distorting the price.
Another notable characteristic of an active market is a lower bid/ask spread. This is the difference between the going rates for buying and selling a particular commodity, stock or other product. The spread exists because somebody buying a stock takes on the risk that they will not be able to sell it the moment they want to. The more active the market, the higher the chance that they won't have to wait so long to find a buyer. The spread is effectively the price the person who want to buy or sell the stock has to pay to ensure they get an immediate deal.
The phrase should not be confused with active market management or investment. This is a strategy in which an investor or fund manager specifically sets out to pick individual stocks or other financial products which they believe will perform disproportionately well. This is distinct from passive market management or investment, which aims to pick a representative range of stocks which performs largely in line with the market as a whole, thus theoretically minimizing both overall risk and the potential for spectacular gains or losses.
@runner101 - I am not sure that I have heard of something in particular causing an active market, but as far as individual company's shares being active, I have heard of it becoming active following rumors of their profit and loss statements or following their actual quarterly report on profits and losses.
I have heard that it is an active market following large market research reports such as government reports on the job market or certain sectors of the job market. For example, if the job market shows high unemployment with little outlook for an upswing in jobs in the following months, people may buy or sell based on the overall job market or a specific sector mentioned in the job market analysis.
For example, if a certain sector saw large job growth, then that might make someone look to buy the stock.
What are some other reasons people have heard of possibly causing an active market?
My trades are usually in small enough lots that it doesn't matter too much how active the market is for them to get filled.
I can see how large companies or fund managers really need an active market to actively trade. Today's market can be quite volatile and making sure there is enough liquidity for large trades would be essential.
I have had situations when a stock is falling quickly and my trade didn't get filled as close to the price as I wanted it to. In an active market that was more balanced, this doesn't happen as often.
I also try to keep a close eye on how close the bid and ask price are. This can often give you a good indication of how much that particular stock might move throughout the day.
I always prefer trading in an active market - especially if I have some low volume stocks that I am trying to buy or sell.
Most of the time my trades have enough volume and liquidity that I don't need to worry about it, but I think an active market is always much more healthy.
This means there is a lot of active trading that is happening and you shouldn't need to worry about your trades being filled.
Post your comments