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What are risks and possible benefits associated with low liquidity?

We’ve discussed at length the benefits of higher liquidity and some of the risks of low liquidity, but it’s worth making those risks explicit, as well as mentioning some of the potential benefits of low liquidity for a trader.

Fundamentally, lower liquidity leads to less stable prices for an asset, meaning that slippage and price manipulation are risks in low liquidity environments, but also, dips in price can be turned into flash crashes. The lack of market participants can lead to long waiting times, which especially during a market swing can be detrimental to a trader.

On the other hand, that lack of stability can be a benefit for a trader. When a large order depresses the price due to low liquidity, an arbitrage opportunity opens up to purchase the asset at a discount.

In general, the most important thing is to understand exactly how liquidity is impacting your trading and to have a coherent strategy that takes these factors into account, deliberately choosing assets and exchanges with an appropriate liquidity environment.

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