Why Liquidity Matters When Buying and Selling Penny Stocks

3 August 2025

Investing in penny stocks can feel like stepping into the Wild West of the stock market—high risk, high reward, and filled with uncertainty. While these low-priced stocks can offer massive gains, they also come with unique challenges. One of the most crucial (yet often overlooked) factors in penny stock trading is liquidity.

Liquidity determines how easily you can buy and sell a stock without drastically affecting its price. But why does it matter so much, especially when dealing with penny stocks? Stick around as we break it all down in simple, digestible terms.

What Is Liquidity?

Before diving into why liquidity is essential for penny stocks, let’s first define what liquidity actually means. In the stock market, liquidity refers to how easily and quickly an asset can be bought or sold without causing a significant price movement.

Think of it like selling a car. If you're selling a brand-new Honda Civic, there's a large market for it, and you can likely sell it quickly at a fair price. However, if you're trying to sell a customized, niche sports car, finding a buyer may take much longer—and you might have to reduce the price to attract interest.

Stocks operate in a similar way. Highly liquid stocks, like shares of Apple or Tesla, have millions of buyers and sellers constantly trading. Penny stocks, on the other hand, often suffer from low liquidity, meaning fewer buyers and sellers are available at any given time.

Now, let’s explore why this is so critical for penny stock investors.

Why Liquidity Is a Big Deal in Penny Stock Trading

1. Liquidity Affects How Fast You Can Enter and Exit Trades

When you're trading penny stocks, timing is everything. If a stock shoots up 50% in a matter of hours, you want to be able to sell quickly and lock in those profits. But if there aren’t enough buyers at the price you want, you might get stuck holding the stock longer than you'd like—or worse, be forced to sell at a much lower price.

Similarly, if you’ve identified a great buying opportunity, low liquidity might prevent you from getting in at the price you want.

2. Large Spreads Can Cut into Your Profits

In a liquid stock, the difference between the buying price (bid price) and selling price (ask price) is typically small. This difference is known as the bid-ask spread.

For penny stocks with low liquidity, the bid-ask spread can be extremely wide. That means you may have to buy at a higher price and sell at a lower price, immediately putting you at a disadvantage.

For example, suppose a penny stock has a bid price of $0.80 and an ask price of $1.00. If you want to sell quickly, you might have to accept $0.80 (which is 20% lower than what you expected). That’s a huge hit to your potential profits!

3. Liquidity Can Reduce the Risk of Price Manipulation

Penny stocks, particularly those traded on OTC (Over-the-Counter) markets, are more prone to manipulation because of their low liquidity. With fewer shares being traded, it takes less money to create artificial price movements.

Scammers often use techniques like pump-and-dump schemes, where they artificially hype up a stock’s price, sell their shares at a high price, and then disappear—leaving unsuspecting investors holding the bag as the price plummets.

Stocks with high liquidity, on the other hand, are harder to manipulate because there are too many market participants for any single group to control the price easily.

4. Lower Liquidity Can Result in More Volatile Price Movements

Low-liquidity stocks tend to have wild price swings. Since fewer shares are being traded, even a small number of buyers or sellers can cause huge price fluctuations.

For instance, if a penny stock only trades a few thousand shares daily, one large buy order can push the price up significantly. On the flip side, if a few investors decide to sell all at once, the stock could nosedive.

While volatility can create opportunities, it also increases the risk of unexpected losses.

5. Liquidity Matters When Trading Large Positions

If you're investing in penny stocks with a small amount of money, low liquidity might not be a big concern. But if you’re trading with a larger amount (say, several thousand dollars), poor liquidity can become a serious issue.

Imagine trying to sell 50,000 shares of a penny stock. If the stock is thinly traded, you might struggle to unload your shares at a fair price. Worse, selling in large quantities could actually drive the price down, meaning you’d be hurting your own returns.

How to Determine Liquidity in a Penny Stock

Now that we know why liquidity is important, let’s talk about how you can measure it when analyzing a penny stock.

1. Check the Average Trading Volume

One of the easiest ways to gauge liquidity is to look at a stock’s average daily trading volume (ADT). This number tells you how many shares are typically bought and sold in a single day.

A stock with a high volume (millions of shares daily) is usually more liquid, while one with very low volume (a few thousand shares) is likely illiquid.

2. Look at the Bid-Ask Spread

As mentioned earlier, a small bid-ask spread suggests high liquidity, while a wide spread signals low liquidity. Checking the difference between the highest bid price and the lowest ask price can give you a good sense of how easily you can enter and exit trades.

3. Watch the Price Action

If a stock’s price moves erratically with very few trades, that’s usually a sign of low liquidity. On the other hand, if the price moves smoothly with steady buying and selling activity, it’s likely more liquid.

4. Use Level II Market Data

Level II market data provides a deeper look at buy and sell orders for a stock. If you see a lot of buyers and sellers at various price levels, that’s a good sign of liquidity. But if the order book is mostly empty, beware—you might have trouble executing trades.

Final Thoughts: Should You Trade Low-Liquidity Penny Stocks?

So, should you completely avoid low-liquidity penny stocks? Not necessarily. Some hidden gems exist in the low-liquidity world, and if you’re willing to hold long-term, liquidity might not be as much of a concern.

However, if you’re an active trader looking to get in and out of positions quickly, liquidity should be one of the first things you check. Low liquidity can trap you in bad trades, force you to take losses, and make it harder to profit consistently.

Bottom line? Always consider liquidity before buying or selling penny stocks. It could mean the difference between a profitable trade and a frustrating loss.