Member-only story
It’s very important to always stay grounded in first principles in many fields, and trading is no different. Academic theories in finance and economics, especially those that make grand conjectures, must ultimately be tied to mundane and concrete market microstructure realities. (There can be much philosophizing about reductionism and reducibility, but as always I’m more focused on practical issues.)
Day traders and the exchanges that serve them all know about the importance, benefits, and costs of liquidity. Liquidity provides for reduction of transaction costs, discovery of market consensus of price and the corresponding implied value, and perhaps most importantly, risk management. Nassim Taleb writes brilliantly in his book “Dynamic Hedging”:
“It cannot be stressed enough that liquidity is the most serious risk management problem. A substantial part of unforeseen losses is due either to market jumps caused by illiquidity or to liquidation costs that substantially move the markets against one’s position.” — Nassim Taleb
Something as valuable as liquidity is a scarce resource just like anything else, so it’s self-evident that market participants…
