What is Thinly Traded?
Thinly traded refers to an investor's inability to sell his or her investment at or near its value in a short amount of time.
How Does Thinly Traded Work?
Things that are thinly traded are essentially issue -- the smaller the number of securities out there or the longer the securities have been out there, the less they tend to be.
Most people consider the size of the bid/ask spread as indicative of whether a security is thinly traded -- the larger the spread, the less liquid (and thus riskier) the security is.
Let’s assume you are watching Company XYZ . If the is $50 and the is $51.50, then the is $0.50. This spread may be high or low depending on what the spread typically is for Company XYZ stock. An increasing spread denotes increasing illiquidity, and vice versa.
Why Does Thinly Traded Matter?
Larger bid/ask spreads (that is, thin trading) generally ask price and sell at the bid price. Thus, the size of the is proportional to the size of the dealer’s profit (although not all of the spread constitutes profit for the dealer -- other fees are part of the spread).
Although the makes the illiquidity of any relatively easy to measure, liquidity risk is harder to get a handle on -- that is, the chance that the spread increase to a concerning size.
In the worst-case scenario, thin trading makes it possible that the investor could take a loss if he or she has to sell an investment quickly. But thinly traded securities can compound other problems for investors. For example, if the investor is unable to his or her position, this may keep him from meeting obligations (that is, the illiquidity increases the investor's credit risk). Buy-and-hold investors face fewer problems due to thin trading because they are generally not interested in buying and selling securities quickly. This is particularly true for buy-and-hold investors, who are simply waiting for their bonds to mature and are not concerned with interim price movements.