The definition and meaning of an active market, in the world of investing and finance is one with heavy volume – lots of trading – and a small bid-ask spread, i.e. there is a small difference between the sell and buy price of shares.
The spread exists because buyers of a stock take on a risk – they might not be able to sell it at precisely the moment they want to. In the very active markets, they are more likely to sell exactly when they want to, because they won’t have to wait long to find a buyer.
The heavy volume may be refer to the market as a whole, a sector, or a particular stock, i.e. a market for a security with a heavy trading volume.
The world’s most active markets are (in order): the New York Stock Exchange, NASDAQ, London Stock Exchange, Japan Stock Exchange, Shanghai Stock Exchange, Hong Kong Stock Exchange, Euronext, Shenzhen Stock Exchange, TMX Group, and Deutsche Börse.
According to the Encyclopedia of Banking & Finance (Eagletraders.com), an active market is:
“One in which the volume of trading is large, whether the trend of prices is upward, downward, or horizontal. Another indicator of market activity for a specific security is the spread between the bid and asked prices therefore; the closer such prices are, the closer to meeting of the minds are buyers and sellers, and so frequent transactions are more likely (trading volume).”
Active market and heavy-volume traders
Investors generally seek out active markets because stocks can be traded, even in great volume, without prices being affected – changes in supply and demand do not have a significant impact on price.
An active market has some distinct features, which bring with them specific opportunities and risks to investors.
This type of market is typically very ‘liquid’. In this context, ‘liquid’ means:
– there are many bid and ask offers
– there are low spreads
– it is easy to execute a trade rapidly
– you are more likely to execute a trade at a desirable price, because there are so many sellers and buyers.
The term ‘active market’ may also refer to real estate activity and prices. London is the most active real estate market in Europe. (Image Data Source: thisismoney.co.uk)
Large institutional investors such as mutual funds, pension funds, insurance companies, money managers, commercial trusts, investment banks, hedge funds, and endowment funds like active markets because they deal in huge volumes – they know that such markets can take it without their transactions distorting the price.
Do not confuse this term with active market management, which is a strategy in which a fund manager or investor sets out to pick specific stocks or other financial instruments which they predict will perform exceptionally well. Active market management is the opposite of passive market management, when a representative range of stocks that perform largely in line with the market in general are selected.
When are markets more active?
When share prices rise, a broader range of investors – members of the public as well as institutional investors – become more speculative in their approach to investment; they are attracted by the advance.
However, bear markets can also become ultra active, especially if investors start to panic.
Just before a major stock market crash, there is usually a bear market, but trading is exceptionally high. In October 1929, for example, stock prices fell steeply; it hit a trading record that was not broken for several decades.
On May 29th, 1962, the US stock market experienced the steepest decline in share prices since October 1929 – it was also the most active market day since 1929.
The Wall Street Crash was the greatest stock market crash in American history. It occurred on the New York Stock Exchange on Black Tuesday, October 29th, 1929. The Crash preceded the Great Depression – it took until late 1954 before stock prices reached their pre-October 1929 levels.
The New York Stock Exchange’s (NYSE’s) most active day was on January 7th, 1981, when ninety-three million shares were traded.
The Wall Street Crash
This video talks about what happened during the Wall Street Crash. On October 29th, 1929, it was an extremely active market, which broke very sharply, taking a huge number of people down with it – it was extremely painful. Within a couple of months, thousands of banks had collapsed.