What does liquidity risk indicate in trading?

• A. The risk of price drops
• B. The risk of not being able to quickly sell or buy an asset
• C. The risk associated with changing markets
• D. The risk of errors in trading

Answer: (B)

Liquidity risk refers to the potential difficulty an investor might face in quickly buying or selling an asset without significantly affecting its price. When liquidity is low, it may take longer to execute trades, and even if a trade is executed, the price may be unfavorable compared to what the investor expected.

In the context of trading, having adequate liquidity means that there are enough buyers and sellers in the market for a particular asset, allowing for smooth transactions. If an asset is not liquid, an investor may find themselves in a situation where they can’t sell quickly enough or may have to accept a much lower price to make a sale.

This concept is essential in trading strategies, particularly in volatile markets, where time and price can shift rapidly. So, understanding liquidity risk is crucial for traders to manage their portfolios effectively and minimize potential losses associated with delays in executing trades.