In financial terms, liquidity is a measurement of how easily assets can be turned into cash. In the stock market, some types of instruments can be traded more easily than others. The debt market, which deals in bonds and notes, also shows liquidity based on how easily these instruments are traded. If an investor can easily sell owned shares and buy new shares whenever she desires, the market is said to be highly liquid. When it is more difficult to find buyers and sellers, the market is less liquid.
In general, higher stock market liquidity means more economic activity, which tends to indicate positive economic conditions. When people are constantly exchanging money on the stock market, they also tend to be more willing to spend money in other areas of the economy. This means that high stock liquidity can be a symptom of healthy activity in all economic sectors.
Stock market liquidity is bound up mostly in business equity, as businesses go public and offer partial ownership in companies. The more liquid the stock market is, the more easily businesses can raise funds by selling equity. This allows businesses to finance more projects and expand more confidently than they would in an inactive stock market, leading to a healthy business sector.
Some economists believe that stock market liquidity can be a negative sign. The more liquid a stock market is, the more dissatisfied investors tend to be, moving from stock to stock in an effort to realize more profit or trade at higher prices. This is theorized to stunt long-term growth and make it difficult to depend on the success of businesses.
Another common theory of stock market liquidity holds that it is like the casino: Success and failure are governed in large part by chance. Over the long term, liquidity has very little to do with the growth of the economy itself, since slower times are eventually canceled out by faster cycles.
originally published in http://www.ehow.com