Could somebody explain how it works? How an investor profit from the trades by following this strategy?
When a security is not liquid, the bid ask spread is higher and transaction costs rise. However, such securities usually sell at a discount to fair value to reflect the lack of liquidity. With improving economic conditions (both macro and micro) and liquidity rises, there will be tendency for for price to move up faster than the general market. Just like every other strategy, there are risks involved. The security may decide to stay illiquid and macro/micro conditions may not improve or investors may just shun the security, regardless.
Awesome!! Thanks a lot.
Nice explanation.
What you are explaining may be correct in other settings. However, liquidity-motivated trading strategy, according to CFAI level III, is something completely different. It means the traders want to liquidate their position urgently/quite soon, but not motivated by information (e.g., inside info or belief that the companies will release bad earnings soon) but by needing the cash (e.g., the investors of their fund want to receive cash) It is not a question whether the traders will benefit by following this strategy. It is a question of their motivation thus requiring a different type of trading/order types appropriate with this motivation than say, info-motivated or passive traders. me.tega Wrote: ------------------------------------------------------- > When a security is not liquid, the bid ask spread > is higher and transaction costs rise. However, > such securities usually sell at a discount to fair > value to reflect the lack of liquidity. With > improving economic conditions (both macro and > micro) and liquidity rises, there will be tendency > for for price to move up faster than the general > market. > > Just like every other strategy, there are risks > involved. The security may decide to stay illiquid > and macro/micro conditions may not improve or > investors may just shun the security, regardless.