What is a thin market?
A thin market on a financial exchange is a period characterized by a small number of buyers and sellers, whether a single stock, an entire sector, or an entire market. A thin market, also known as a narrow market, can lead to price volatility.
- In a thin market, there are few active participants on the buy side or sell side.
- Price volatility in thin markets tends to be greater than normal.
- A thin market is the opposite of a liquidity market, which has enough participants to balance buyers and sellers.
Understand the thin market
Thin markets have high price volatility and low liquidity. The balance between supply and demand can drop sharply, which can have a significant impact on prices. Potential buyers and sellers may even find it difficult to trade, as few bids and asks are quoted.
The overall volume is small, but individual transactions tend to be large. In other words, price fluctuations are large. In addition, the spread between the bid and ask prices of an asset tends to be wider as traders seek to profit from a small number of market participants.
A thin market is the opposite of a liquidity market, which is characterized by a large number of buyers and sellers, strong liquidity, and relatively low price volatility.
Liquidity, by definition, is a measure of the ease and speed at which an asset can be converted into cash with a fair estimate of its value. Bank cash is a liquid asset. That’s not the case with home and Old Master paintings.
Generally speaking, stocks can be considered liquid assets. They are easy to sell at any time and cash will be available with only a short delay. Unless the seller chooses a loser, it should be more than the original cost.
However, by its very nature, thin markets impair liquidity. Individual investors may find it difficult or impossible to get a fair price in a thin market.
The thinnest market on Wall Street occurs each year in late August, when most traders abandon their desks and go to the beach.
Individual investors are wise to stay out of the way of thin markets.
Impact on transactions
When transaction-level data first became available in the early 1990s, the impact of institutional investors on thin and general market prices became apparent for the first time. Trading by some large institutions accounts for more than 70% of the daily trading volume of the New York Stock Exchange (NYSE).
This means that they must take into account the size of their own orders in their trading strategies. Large traders divide their orders into smaller blocks and place them in a series of transactions that are staggered over time.
Currently, more than half of transactions by large institutions take at least four days to complete. If they push all the trades at once, the price they paid to buy the stock or received to sell the stock will be adversely affected by their own trade.