Qualitative Analysis – Liquidity crisis and profitability

Qualitative analysis written by Stelios Nikolaou.

Liquidity crisis and profitability

After the recent FTX crisis and the procyclicality amidst it, scholars, traders, investors, and bystanders of the financial world, have started wondering about how can a liquidity crisis affect the price, and the potential profitability of a trader or an investor.

By ignoring the reasons as to why there is a liquidity crisis in the first place, or how it came to be, the most important point to note would be to even know what a liquidity crisis even is.

In plain words, a liquidity crisis is any situation that arises during recessions, where, for reasons to be analyzed another time, individuals and firms want to pile up their liquid assets, cash and securities holdings, so that they can exchange them for cash easily at a predictable price, since the heightened risk (or the perception thereof) will have increased the demand for these assets, effectually reducing the available supply for normal transaction, and consequently leading to production and employment declines.

The above sample of what happens at a liquidity crisis, has a rather practical translation, over how any financial analyst can grasp their opportunity through it all; in 2008, the crisis meant that profit could be made from shorting the housing market, which was about to crumble down, just as it happened eventually.

Likewise, in 2022 perhaps, the liquidity crisis that FXT, and which has led investors withdrawing large amounts of coins from crypto exchanges, might invoke the phenomenon of procyclicality, and to eventually lead the prices of crypto assets to lower, thus giving a financial opportunity for long term profitability (Assuming the given exchange and assets will have ample leverage to remain standing until the uptrend begins); Or as the slang word explains better, it would allow people to buy the dip and wait for the pump.

Regarding the crypto asset world, there has been some speculation regarding the regulatory future of said assets, while at the same time the overall market imbalance post-Covid threatens to undermine efforts to limit the effect of inflation, non-excluding the fact that central banks claim to be prepared in terms of tackling liquidity crises and monetary overkill.

Such a tendency as the one described above, quite speculatively, might end up in production and employment declines, and perhaps even heightened inflation (Which will eventually lead to a decrease in the purchasing power of money), thus negating the current effect of the lower price opportunistic environment. 

Thus, it would be safe to speculate, that if an experienced person takes up on the opportunity that a liquidity crisis entails, and is somehow spared from defaulting, then they would find themselves in a financial opportunistic event with qualities similar to a butterfly effect; Where the insolvency of several big-time companies, the fluctuation in prices, or broadly another financial crisis, will result in their profit enrichment.

Concluding, as a leading investment firm, AAATrade, warns its investors and traders to be careful in the dealing of assets during a liquidity crisis. As such, it also encourages them to be educated and well-informed prior to investing in new products/companies. Therefore, we offer a vast variety of products to invest in, that can fit the profit/risk model of the novice and professional clients, as well as the necessary analysis material for them to base their choices on.