What is liquidity (and market depth)? The trading minute

You never bathe twice in the same river. Liquidity refers to the ease with which an asset can be bought or sold without affecting its price, and it changes constantly from hour to hour and from one platform to another. It determines the spread you pay, and it also decides whether your sell order on a Sunday evening will execute at the displayed price or ten ticks lower. Invisible in good weather, decisive in bad weather. Demonstration by disaster.

Liquidity and market depth, definitions

Liquidity is reflected in the order book. Market depth is the amount of buy and sell orders stacked at each price level around the market price. A deep market absorbs a large order without flinching, with each level of the order book taking its share. A shallow market, on the contrary, allows the same order to tumble down the empty levels, and the price drops well beyond what the seller imagined. This is the infamous slippage.

Remember that the displayed depth is a snapshot, not a promise. Market makers withdraw their orders in a few milliseconds as soon as a storm threatens. The order book empties precisely when it is needed. These professionals are paid to maintain depth, but no contract obliges them to stay under the storm. Two order books: deep vs shallow. Diagram: Journal du Coin

February 22, 2021: Ether at $700 on Kraken, $1,546 elsewhere

The case study takes place over a morning. On that Monday, during a market correction, ether is trading around $1,600 when, on the Kraken platform, the price collapses in a few minutes to $700, while the rest of the market only drops to about $1,546, as reported by CoinDesk. No bug according to the platform's CEO, just large sales hitting a local order book too thin to absorb them.

Minus 56% on one platform, minus 4% elsewhere, at the same moment, for the same asset. The stops and leveraged positions lodged on this book were executed in the void, at nightmare prices. Customers demanded refunds for weeks, with little success.

Trading liquidity in particular: good reflexes

Three habits protect against shallow order books. Trade major pairs on deep platforms, where your size is a drop in the ocean. Beware of off-peak hours, nights, weekends, and American holidays, when depth dwindles and wicks lengthen. And for any unusual size, slice your orders and use limit orders, never a market order thrown into the fog. A glance at the order book before clicking takes three seconds and avoids many unpleasant surprises.

Let's broaden to conclude the week. Liquidity is the raw material of all the previous episodes; it absorbs or amplifies liquidation cascades, it makes arbitrage possible, and its drying up transforms a correction into a flash crash. Markets rarely die from a drop. They die from illiquidity.

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