Take advantage of low liquidity markets
- Why choose low liquidity markets instead of high liquidity markets?
Well, simply because there are more opportunities in low liquidity markets. Usually, low liquidity markets are inefficient. In the book The Wisdom of Crowds, James Surowiecki pointed out that crowds have huge implications for how the markets are estimated. Suppose there is a contest where all the participants guess one elephant’s weight and the one who give the closest number wins. Participants are not allowed to collaborate or follow the “smart” guy. Surprisingly, the organiser found that the average number of all answers is quite close to the real weight.
In a market, traders estimate the price in various ways. Some trader values the markets higher while others pricing lower. If the trading volume is large enough, the price would be close to the true value. Low liquidity markets are more likely to be priced incorrectly. In addition, large players such as investment banks and hedge funds are not interested in low liquidity markets because of low market cap and high impact costs. As a result, there are relatively more mug money. As a retail trader, we could make an enormous profit in low liquidity markets if we deal with them properly.
- Why some markets are of low liquidity?
It will be easier to find your own margin if we understand the markets deeply. Most stocks are unpopular and we rule out this kind of markets because there is no opportunity.
Some index futures (along with other derivatives) are inactive in a certain period of time in a day because of the time zone. For example, Dax30 is traded between 8 am and 10 pm (GMT +1) in The German stock exchange. It’s also accessible in other times over the counter (OTC). Apparently, the OTC markets is of low liquidity.
The other situation is that one company is listed in more than one exchange. It’s pretty common that Chinese companies are listed in the mainland and Hong Kong (or the US) at the same time. It does not guarantee an arbitrage opportunity. But sometimes it does generate arbitrage opportunity with no risk at all!