Liquidity risk refers to the risk that an investor may not be able to buy or sell a security, such as a stock, at a desired price or in the desired quantity due to a lack of market participants or insufficient trading volume.
In the context of stock markets, liquidity risk arises when there is not enough trading volume for a particular stock, resulting in a wide bid-ask spread, which is the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept. When liquidity is low, it can be difficult for investors to buy or sell a stock quickly without affecting its market price.
Investors face liquidity risk when they are unable to buy or sell a security at a desirable price or time, which can result in increased transaction costs, potential losses, or missed investment opportunities. Therefore, it is important for investors to consider liquidity risk when making investment decisions, particularly for those investing in stocks that are less liquid or during times of market stress.