What is liquidity risk?

Liquidity risk refers to the challenge an investor faces when they may be unable to quickly buy or sell an asset without significantly affecting its market price. This can occur when there are few buyers or sellers in the market, making it difficult to complete a transaction at the desired price.

For instance, if an investor holds a security that has low trading volume, they might struggle to sell it quickly without having to lower their asking price, resulting in a financial loss. Thus, liquidity risk is particularly relevant for assets that are not frequently traded or are otherwise difficult to convert into cash promptly. Understanding liquidity risk is crucial, as it can impact an investor's ability to react to market changes or financial emergencies where quick access to cash is necessary.

Other concepts like market price fluctuations and losses from bankrupt companies are related to different types of investment risks, not specifically to liquidity risk.