Liquidity is a key factor for traders to determine whether they can trade actively in a given market.
Three fundamentals dictate market liquidity – volume, open interest, and the bid-ask spread.
- Volume is the number of contracts traded in each product over a specific period – usually the trading day. Generally speaking, traders should look to trade the contract with the highest volume for the period.
- Open interest is the total number of contracts currently ‘open’ – meaning they have been bought or sold but not closed out– in the market for a given expiration month. High open interest indicates market liquidity.
- The Bid-Ask spread is the number of ticks that separate the highest bid from the lowest offer. Generally, a narrow the bid-ask spread indicates more participants in the market, and more liquidity.
Traders can utilize these three fundamental indicators to determine if the position they wish to enter can be closed with ease.