When Does The Market For A Preferred Stock Become 'Illiquid?'

The financial press will occassionally caution investors about an 'illiquid market.'

But what constitutes an illiquid market for a preferred stock you may be considering and how does one tell before placing your order?

An illiquid market can occur when there are so few buyers and sellers that it becomes essentially impossible for any buy or sell order you may place to be filled. You'd hate to put together a plan to do a trade only to find out that, when you do so, your order just sits there day after day.

The degree to which the market for a particular preferred stock is 'illiquid' depends on the volume of shares that you are looking to buy or sell. What is illiquid to some investors will not be to others.

Look at it this way: Let’s say that you are looking to buy 100,000 shares. When you look up the daily volume of your preferred stock you see that it trades about 10,000 shares per day. You may still be able to buy 100,000 shares (10 times the daily volume), but it will take a very long time. Your buy order will sit there and get partially filled, a little here, a little there, day in and day out, probably for weeks. In the eyes of this buyer, the market for this preferred stock is extremely illiquid.

Now take a second case: Let’s say that you are looking to buy 10 shares of the same preferred stock. With a volume of about 10,000 shares per day, buying 10 shares is a snap; no problem. Your buy order will fill in seconds, if that. What illiquid market?

The degree to which the market for a stock is 'illiquid' depends on the percentage of the daily volume that you are trying to transact; in other words, the ratio of the number of shares that you are trying to buy or sell to the total daily volume of the preferred stock.

Here’s a rule of thumb that I use for CDx3 Preferred Stocks (nothing scientific here, just something I’ve noticed by watching every day): Your buy or sell order, placed in the morning at the 'Last' price, will generally fill the same day if you are buying/selling up to about 5%-7% of the daily volume. So if I were to place a morning buy order at the Last price for 700 shares, and the average daily volume was 10,000 shares, the order will almost certainly fill within the same day. If you try to buy/sell something closer to 10% of the average daily volume, your order may very well take more than a day to fill.

Online quoting services typically provide the day's share volume whenever you request a quote and most charting web sites will show the daily share volume along with the daily closing price history. If you are counting on your trade filling quickly (same day), it would be a good idea to understand what percentage of the daily volume you are transacting before you place your order. This can be especially true for older preferred stocks that either have a relatively low declared dividend rate or have already passed their call date.

Thanks to subscriber Alvaro P. for submitting this question.

Many Happy Returns.