What does 'liquidity' refer to in the context of trading?

Liquidity, in the context of trading, refers to the ability to buy or sell an asset without causing a significant change in its price. When a market is liquid, there are enough buyers and sellers for an asset, which means that assets can be purchased or sold quickly and at stable prices. This characteristic is vital for traders because high liquidity allows for efficient transaction execution, reducing the risk of slippage—where the final execution price differs from the expected price due to lack of available supply or demand.

In contrast, choices such as the ability to hold an asset for a long period, the ability to predict market trends successfully, and the ability to leverage an asset for additional investment do not accurately define liquidity. Holding an asset refers to the duration of ownership, predicting market trends involves analysis and forecasting, and leveraging assets deals with using borrowed funds to increase investment capacity—all of which are separate from the fundamental concept of liquidity in trading.