Recently, I purchased shares in a company thinking that I'd get in and out again in the same day with a bit of profit to show for my clever technical analysis of the stock's trend. Trading volume also looked good to me, when viewing nothing more than the number of shares traded.
What I wound up with was thousands of stock shares that took more than two weeks to unload, even though my asking price had been reached several times over the course of my holding.
What I neglected to do was to consider the trading liquidity of the company's stock. That is to say, I didn't consider the average number of shares traded in relation to the number of shares outstanding and in circulation for the company.
Since that blunder, on my part, I have revised my method of screening for stocks to include a simple formula which estimates a stock's trading liquidity ratio (TLIQ). The formula is simple -
TLIQ = Average Volume(100) / Shares Outstanding in Millions
(Note that I didn't develop this formula. It can be found at barcharts.com.)
The higher the TLIQ, the more liquid the stock will be and the easier it will be to exit a position in the stock when the target price has been attained. Stocks having a TLIQ less than 1 would be considered illiquid, meaning that it could take days, weeks, or even months to exit a position in the stock.
The reason for this is simple... a stock having a 100-day average volume of 50,000 is most certainly going to have a large number of days where actual volume was only 100 or 200 shares per day. If a company has 13.7M shares outstanding, it is a fairly decent bet that there will be more than one single shareholder attempting to sell his shares at any given price, and odds are great that many of those shareholders are trying to sell more than 100 shares.
Without an adequate number of buyers, the sellers are left to dangle in the wind waiting in queue for someone to come along and relieve them of the shares that they are so eager to sell.
So, how liquid are your stock holdings?
Apply the formula above to the stocks in your portfolio and see for yourself. If you discover that the TLIQ of your stocks is less than 1 (I personally prefer a minimum of 5), it may be time to revise your stock selection criteria as well.
After all, it really doesn't make any sense at all to purchase a stock which you may have difficulties selling when needed.