At SmartCapitalMind, we're committed to delivering accurate, trustworthy information. Our expert-authored content is rigorously fact-checked and sourced from credible authorities. Discover how we uphold the highest standards in providing you with reliable knowledge.
"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.