What is Liquidity and Why is it Important?

Liquidity is a measure of how much money is flowing into or out of the stock market. The stock market needs lots of liquidity (money) flowing in for prices to rise. The definition of a Bull Market is prices going up because money is flowing into the market and investors are buying stocks, mutual funds and ETF’s.

Conversely, when the flow of money (liquidity) into the stock market slows or stops, prices have a difficult time staying up because there is not as much money flowing to support prices, and the longer this goes on the more likely a correction in stock prices becomes.

If you can accurately measure the level of liquidity either flowing into or out of the stock market, then you can have a very good idea about when to buy or when to sell.

EquitySurge™ is a proprietary measure of liquidity. When EquitySurge™ generates a Buy Signal this means that liquidity (money) is flowing into the stock market and liquidity conditions are becoming supportive of higher stock prices. As long as EquitySurge™ maintains the Buy Signal, liquidity conditions remain supportive and this indicates that prices should continue to rise.

When the flow of money into the stock market begins to slow or even stops, a Sell Signal will be generated. This means that the fuel for higher stock prices, money, is no longer flowing, and it’s time to consider selling stocks, establishing a hedge, or even going short the stock market.

RRG® Graphs:

We use RRG® graphs to show the relative strength and momentum of a group of liquidity benchmarks versus broad-based USA stock indexes. When the liquidity benchmarks show strong relative strength and momentum they appear in the green Leading quadrant. This means liquidity conditions are favorable for establishing and holding long equity positions. As the relative momentum of the liquidity benchmarks fades, they start moving into the yellow Weakening quadrant. If relative strength also then fades, they move into the red Lagging quadrant, which means that liquidity conditions are now unfavorable for holding long equity positions, and stocks should be sold or even shorted. Finally, when momentum starts to pick up again, meaning liquidity conditions are improving, they shift back into the blue Improving quadrant.

The liquidity benchmarks we use are the VIX Index, the Chicago Board Options Exchange’s CBOE Volatility Index, a popular measure of the stock market’s expectation of volatility based on S&P 500 index options, the Hang Seng Index in Hong Kong, an excellent benchmark for global liquidity conditions, HYG, a high yield bond ETF, TLT, a 20+ Year US Treasury Bond ETF, and the commodity Copper, an excellent barometer of global industrial economic activity. Each of these provides deep insight into current liquidity conditions in the stock market.

The Relative Rotation Graphs are provided by StockCharts.com, Simply the Web’s Best Financial Charts.

The terms Relative Rotation Graph and RRG are registered trademarks of RRG Research.