Active market – definition and meaning
An active market, in investing and finance, is one with lots of trading and a small bid-ask spread. A small bid-ask spread means a small difference between the sale and purchase price of shares.
The spread exists because buyers of a stock take on a risk. Stock buyers might not be able to sell them at precisely the moment they want to. In the very active markets, however, they are more likely to sell exactly when they want to. They can sell when they want to because they won’t have to wait long to find a buyer.
The ‘heavy volume’ may refer to the market as a whole, a sector, or a particular stock, i.e. markets for securities with heavy trading volumes.
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 Free Dictionary by Farlex, an active market is:
“A market for a security with a high trading volume. Many investors look to active markets because they can be traded, even in rather large quantities, without affecting the price. Securities with active markets usually have low bid-ask spreads.”
Active market and heavy-volume traders
Investors seek out active markets because they can trade in stocks without prices being affected. In other words, changes in supply and demand do not have a significant impact on price. Very heavy volumes do not affect prices.
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, and
- you are more likely to execute a trade at a desirable price. Prices are better when there are many sellers and buyers trading.
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. They like active markets because they deal in huge volumes. In other words, they know that such markets can take it without their transactions distorting the price.
Do not confuse this term with active market management. Active market management refers to a strategy in which fund managers pick specific financial instruments. They pick those instruments because they predict that they will perform exceptionally well.
Financial instruments are monetary contracts between parties which people can buy and sell.
Active market management is the opposite of passive market management. With passive market management, the investor selects a representative range of stocks that perform largely in line with the market in general.
When are markets more active?
Bull markets – when stock prices are rising – tend to be the most active. Bear markets – when share prices are declining – on the other hand, are generally the least active. In this article, the terms ‘stock’ and ‘share’ have the same meaning.
When share prices rise, a broader range of investors become more speculative in their approach to investment. Not only institutional investors, but also members of the public become more speculative with the advance.
However, bear markets can also become ultra active, especially if investors start to panic. Hence, market authorities are forever monitoring activity and sentiment to in case of a mass 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. During that month, US markets hit a trading record that held 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 trading volume reached ninety-three million shares.
The Wall Street Crash
This video talks about what happened during the Wall Street Crash, which occurred on October 29th, 1929. The market was extremely active but then broke very sharply. When things came tumbling down, a huge number of people fell with it.
The Wall Street Crash was probably the financially most painful event in 20th century US history. Thousands of banks subsequently collapsed within a couple of months of the crash.