Relationship between liquidity and an efficient market
"Liquidity is highly correlated to efficiency primarily because if an asset's price is not sampled during the time of a trade, it's price is unknown therefore inefficient.  Past prices can be referenced, but they are not the price of the present.  Prices of substitutes are even worse. SPY is extremely efficient for an equity.  If permitted, it could easily trade with much lower ticks and still have potential for a locked market. Ideal exchange An ideal exchange has no public restrictions on trade.  This is not to say that private restrictions would need to be put in place for various reasons, but one would only do that if it were responsible for its own survival instead of being too big to fail. In this market, trades would be approximately continuous for the largest securities and almost always locked because of continuous exchange fee competition with ever dropping minimum ticks. A market that can provide continuous locked orders with infinite precision is perfectly efficient from the point of view of the investor because the value of one's holdings are always known. EMH In terms of the theory the Efficient Market Hypothesis this is irrelevant to the rational investor. The rational investor will invest in the market at large of a given asset class, only increasing risk as wealth increases thus moving to more volatile asset classes when the volatility can be absorbed by excess wealth. Here, liquidity is also helpful, the ""two heads are better than one"" way of thinking.  The more invested in an asset class, the lower the class's variance and vice versa.  Bonds, the least variant, dwarf equities which dwarf options, all in order of the least variance.  Believe it or not, there was a day when bonds were almost as risky as equities. For those concerned with EMH, liquidity is also believed to increase efficiency in some forms because liquidity is proportional to the number of individuals invested thus reducing the likelihood of an insufficient number of participants. External inefficiency In the case of ETFs that do not perfectly track their underlying index less costs at all times between index changes, this is because they are forbidden from directly trading in the market on their own behalf. If they were allowed and honest, the price would always be perfect and much more liquid than it otherwise should be since the combined frequency of all index members is much higher than any one alone. If one was dishonest, it would try to defraud with higher or lower numbers; however, if insider trading were permitted, both would fail due to the prisoner's dilemma that there is no honor among thieves.  Here, the market would detect the problem much sooner because the insiders would arbitrage the false price away.   Indirect internal efficiency Taking emerging market ETFs as an example, the markets that those are invested into are heavily restricted, so their ETF to underlying price inefficiencies are more pronounced even though the ETFs are actually working to make those underlying markets more efficient because a price for them altogether is known."
Timing the market and by extension the efficient market hypothesis is one of the most hotly debated subjects in finance academia. If you are to believe the majority of finance professors and PHD's out there chances of timing a market like the NYSE, NASDAQ or LSE is not possible. If you are to take into account the huge amount of hedge funds and money managers who make it their job to prove the efficient market hypothesis wrong then you may have a chance. My opinion is that the EMH is true and that timing a highly efficient market like the NYSE is very difficult or impossible even for those who spend their whole lives trying to beat it. For someone whose primary job isn’t in investments I would put the idea of timing the markets out of your head. "If markets are efficient they will be unpredictable.  If all past information is already priced into a stock then movement will only occur when new information is introduced.  Since no one can predict future events stocks will move in an unpredictable way.  If markets are inefficient in the short term, people should be able to figure out the long-term price movements.  This doesn't seem to be the case.  This is why the authoritative book on market efficiency is called ""A **Random** Walk Down Wall Street""." Option liquidity and underlying liquidity tend to go hand in hand. According to regulation, what kinds of issues can have options even trading are restricted by volume and cost due to registration with the authorities. Studies have shown that the introduction of option trading causes a spike in underlying trading. Market makers and the like can provide more option liquidity if there is more underlying and option liquidity, a reflexive relationship. The cost to provide liquidity is directly related to the cost for liquidity providers to hedge, as evidenced by the bid ask spread. Liquidity providers in option markets prefer to hedge mostly with other options, hedging residual greeks with other assets such as the underlying, volatility, time, interest rates, etc because trading costs are lower since the two offsetting options hedge most of each other out, requiring less trading in the other assets. It's not about moving the market or liquidity the non current months have reduced liquidity, checking today.  ES_F June today the most recent 5 min bar has 809 volume. while the september has 10616 volume on the same bar.  2. Commision p/l should be subtracted as actual actual.  I'm not necessarily worried about moving the market or liquidity im more or less worried about slippage. As some good strategies can decay very fast due to it. I'd think that liquidity and speed are prioritized (even over retail brokers and in come cases over PoP) for institutional traders who by default have large positions.  When the going gets tough, these guys are out and the small guys - trading through average retail brokers - are the ones left holding the empty bag. Depends on how you measure liquidity.  There's papers out there that approach this very question. Measured in order book spreads for a consolidated $100m trade, I'd say the second biggest market is FX swaps, followed or par'd by the money market (government bonds). If you disallow OTC venues, it's most definitely exchange listed government bonds. If, however, you happen to think in terms of sheer volume per time, the most liquid market phase could be considered the NYSE closing auction, as you can move billions in a matter of minutes, or expressed in speed terms: several m$/s (million dollars per second). You should pick a definition and we can provide you with a more accurate list of candidates and actual data. You will tend to find as options get closer to expiry (within 2 months of expiry) they tend to be traded more. Also the closer they are to being in the money they more they are traded. So there tends to be more demand for these options than long dated ones that are far out of the money. When there is this higher demand there is less need for a market maker to step in to assure liquidity, thus there should be no effect on the underlying stock price due to the high demand for options. I would say that market makers would mainly get involved in providing liquidity for options way out of the money and with long periods until expiry (6+ months), where there is little demand to start with and open interest is usually quite low. This has never really adequately explained it for me, and I've tried reading up on it all over the place. For a long time I thought that in a trade, the market maker pockets the spread *for that trade*, but that's not the case.  The only sensible explanation I've found (which I'm not going to give in full...) is that the market maker will provide liquidity by buying and selling trades they have no actual view on (short or long), and if the spread is higher, that contributes directly to the amount they make over time when they open and close positions they've made.  It would be great to see a single definitive example somewhere that shows how a market maker makes money. Stock prices are indeed proportional to supply and demand. The greater the demand for a stock, the greater the price. If they are, would this mean that stock prices completely depend on HOW the public FEELS/THINKS about the stock instead of what it is actually worth? This is a question people have argued for decades. Literature in behavioral finance suggests that investors are not rational and thus markets are subject to wild fluctuation based on investor sentiment. The efficient market theory (EMT) argues that the stock market is efficient and that a stock's price is an accurate reflection of its underlying or intrinsic value. This philosophy took birth with Harry Markovitz's efficient frontier, and Eugene Fama is generally seen as the champion of EMT in the 1960's and onward.  Most investors today would agree that the markets are not perfectly efficient, and that a stock's price does not always reflect its value. The renowned professor Benjamin Graham once wrote: In the short run, the market is a voting machine but in the long run it is a weighing machine. This suggests that prices in the short term are mainly influenced by how people feel about the stock, while in the long run the price reflects what it's actually worth. For example, people are really big fans of tech stocks right now, which suggests why LinkedIn (stock: LNKD) has such a high share price despite its modest earnings (relative to valuation). People feel really good about it, and the price might sustain if LinkedIn becomes more and more profitable, but it's also possible that their results won't be absolutely stellar, so the stock price will fall until it reflects the company's fundamentals. The relationship is not linear, and depends on a lot of factors. The term you're looking for is efficient frontier, the optimal rate of return for a given level of risk. The goal is to be on the efficient frontier, meaning that for the given level of risk, you're receiving the greatest possible rate of return (reward). http://www.investopedia.com/terms/e/efficientfrontier.asp "No one can claim markets are perfectly efficient. The Grossman-Stiglitz paradox explains one reason why it is impossible for the market to be perfectly effecient, and there are plenty of investors that show it is practically possible to consistently beat the market (e.g. ""The Superinvestors of Graham-and-Doddsville"" or RenTec's Medallion Fund).  However, even if you accept as true that prices behave strangely around round numbers, that isn't a refutation of the efficient market hypothesis. The efficient market hypothesis says that price reflect all available information, so the expected price tomorrow is just the price today (not taking into account the time value of money).  The efficient market hypothesis says nothing about how prices are distributed. Historically, a random walk has been used, but that is neither a consequence of the EMH nor a required assumption.  You could say that prices are more volatile the nearer they are to a round number or new high, but that doesn't necessarily give you an edge in making money off the stock." Markets are rational in the long term. Actors act rationally given the knowledge they have. They don't have perfect knowledge - meaning they're prone to make mistakes. However, in the LONG run, every would be a equilibrium.   Facebook stock is clearly over valued and the market is adjusting to the real price. Nothing spectacular going on there. Investors already can trade their assets - simply tokenizing a bond is unlikely to make it more liquid.  The key to liquidity is having a willing counterparty who wants to buy/sell what you are looking to sell/buy.  Because debt can be structured in a myriad of ways, markets for some bonds will be extremely thin, with limited buyers and sellers.  I don't see how tokenization will solve that problem. "You are right, if by ""a lot of time"" you mean a lot of occasions lasting a few milliseconds each. This is one of the oldest arbitrages in the book, and there's plenty of people constantly on the lookout for such situations, hence they are rare and don't last very long. Most of the time the relationship is satisfied to within the accuracy set by the bid-ask spread. What you write as an equality should actually be a set of inequalities.  Continuing with your example, suppose 1 GBP ~ 2 USD, where the market price to buy GBP (the offer) is $2.01 and to sell GBP (the bid) is $1.99.  Suppose further that 1 USD ~ 2 EUR, and the market price to buy USD is EUR2.01 and to sell USD is EUR1.99.  Then converting your GBP to EUR in this way requires selling for USD (receive $1.99), then sell the USD for EUR (receive EUR3.9601).  Going the other way, converting EUR to GBP, it will cost you EUR4.0401 to buy 1 GBP.  Hence, so long as the posted prices for direct conversion are within these bounds, there is no arbitrage." I agree.  My biggest disagreement with the article is the stigma against the rebates offered by exchanges.    These are offered for providing liquidity to the markets, and are an added incentive to both market makers and institutional (and now retail) clients to post orders and provide liquidity for other participants to interact with.  We have some market making strategies that make very little in gross P&amp;L (i.e., capturing the spread), but net P&amp;L is much higher due to the rebates we get for maintaining quotes and providing liquidity throughout the day, especially in illiquid/small cap names where spreads would be wide if they relied purely on retail/institutional flow.  I'm surprised the author didn't talk about inverted exchanges (Bats Y, Edge A) where participants receive rebates for taking liquidity instead of providing it.  Those models essentially reward people who need immediate execution - does he see a problem with those or should they be exempt?