Daily Gains Letter

Two Easy Strategies for Exiting an Illiquid Position

By for Daily Gains Letter |

Strategies for Exiting an Illiquid PositionWhen it comes to investing in the stock market for the long term, one of the key elements investors should keep in mind is the liquidity of their investment. Oftentimes, investors might buy into companies with no or minimum liquidity, thinking things will get better. As time passes and their investment grows, they eventually run into a problem—they have to sell it to register their gains, and this can only happen if someone is willing to buy their shares.

The word “liquidity” is thrown around often by analysts to explain the financial situation of a company, but in the context of this article, “liquidity” refers to how quickly an investor can turn their investment into cash without moving the price of a stock significantly higher or lower—or, simply stated, the ability to sell and buy with ease.

Stocks are considered very liquid in the world of investing. Investors can sell them fairly quickly, but there are places in the stock market where they have to be really careful. Consider a penny stock that has a volume of, say, less than 1,000 shares a day. If an investor holds 10,000 shares of the company, it can be very difficult for them to sell their position without moving the price lower.

One strategy investors can use is to sell their position multiple times by using market orders. Going back to our example: if an investor holds 10,000 shares of a company, they might want to consider selling 500 shares or so at a time. This way, they may not move the price as much, and may be able to liquidate. A major problem an investor will face by doing this is that they will have to pay a lot of commission, which may end up erasing their gains.

Another strategy they might want to consider is selling with a limit in place at a desired price. What this strategy essentially does is it locks in the price, and the order is not executed until the broker is able to get the limit price or better. Once again, a major setback with this is that the limit order may be sitting in a queue for a long time, and the investor may be stuck with their holdings in the meantime.

The example above was the scenario for when investors want to take gains, but in times of stock market turmoil, liquidity can cause even more troubles and bring misery to an investor’s portfolio.

This is mainly because in a broad market sell-off, if investors are stuck with illiquid stock, they may not be able to sell their holdings quickly, and losses might just continue to mount higher, as buyers control the market—they can even dictate the price they want to buy.

Investors who are saving for retirement should try to stay away from investments that are illiquid, because when it comes time to sell them, they might not be able to do so. Even with all this, if you do attempt to enter an illiquid investment, at least make sure you only put up a portion of your portfolio towards it.

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