Trading Volume

B is correct. The client's 25,000-share sell order represents 83% of the stock's average daily volume (25,000 ÷ 30,000 = 83%). Attempting to sell such a large percentage of daily volume in a low-liquidity stock will likely push the price down as the order overwhelms available buyers, resulting in poor execution and potential losses for the client. This liquidity risk is Marcus's primary concern.

A is incorrect because market capitalization indicates company size, not trading liquidity or execution risk. Many small-cap stocks are legitimate investments; the issue here is trading volume, not market cap. C is incorrect because while a $0.75 spread on a $20 stock (3.75% spread) is wide, the primary concern is the volume shortage—even with a tight spread, selling 83% of daily volume will move the price. D is backwards: the client owns TOO MUCH relative to daily volume, which is precisely the problem. If the order were small relative to volume (e.g., 1,000 shares), execution would be much easier.

B is correct. High trading volume indicates that many shares change hands during a typical trading period, reflecting strong investor interest (either buying or selling). This high volume typically provides better liquidity, meaning investors can more easily buy or sell shares without significantly impacting the price. Good liquidity results in tighter bid-ask spreads and better execution quality.

A is incorrect because volume indicates activity level but not price direction. High volume can occur during both rising markets (buyers active) and falling markets (sellers active). Volume analysis alone does not predict future price movement. C is incorrect because trading volume and market capitalization are different metrics. A small-cap stock can have high volume if it's actively traded, while a large-cap stock can have low volume if there's little investor interest. Volume measures trading activity, not company size or fundamentals. D is incorrect because high volume does not indicate valuation. Active trading can occur in fairly valued, undervalued, or overvalued securities; volume reflects interest and liquidity, not intrinsic value.

B is correct. ETF X's substantially higher trading volume (8 million vs 200,000 shares daily) provides much better liquidity, reflected in its tighter bid-ask spread ($0.02 vs $0.15). Higher volume means more buyers and sellers are active in the market, making it easier to execute trades at favorable prices without impacting the market. The tighter spread also means lower transaction costs for the client. For a $250,000 allocation, execution quality matters significantly.

A is backwards: higher volume is advantageous because it provides better liquidity and execution, not a disadvantage. More trading activity means easier order execution at fair prices. The "competition from other investors" concept misunderstands how liquid markets work—more participants create better price discovery and lower costs. C is incorrect because even though both ETFs track the same index (same holdings and performance), trading characteristics differ significantly. Volume and spread directly affect transaction costs and execution quality, which impact the client's net returns. Poor execution in ETF Y could cost the client significantly more despite identical index exposure. D is incorrect because wider spreads reflect lower liquidity (fewer market participants), not lower volatility. In fact, low-volume securities often experience MORE volatility because individual trades have greater price impact when there are fewer offsetting orders.

C is correct (the EXCEPT answer). Trading volume does NOT indicate price direction. High volume can occur during both price increases (strong buying) and price decreases (strong selling). Volume measures the level of trading activity and liquidity, not the direction of price movement. A security can experience high volume during a steep decline just as easily as during a rally.

A is accurate: high trading volume indicates many shares are changing hands, which provides better liquidity (ease of buying or selling) and typically results in better trade execution with less price impact. B is accurate: trading volume is indeed defined as the total number of shares (for stocks) or contracts (for options, futures) traded during a specific period, typically measured on a daily basis. D is accurate: securities with low trading volume have fewer buyers and sellers in the market, leading to wider bid-ask spreads (the difference between what buyers will pay and sellers will accept) and higher transaction costs due to reduced liquidity and market depth.

C is correct. Statements 1, 2, and 3 are all relevant considerations when evaluating this low-volume, wide-spread security.

Statement 1 is TRUE: The 5,000-share purchase represents 33% of the stock's average daily volume (5,000 ÷ 15,000 = 0.33). Buying one-third of typical volume in a single order will likely push the price upward as the order absorbs available sellers, resulting in worse execution than the quoted price. The adviser should consider breaking the order into smaller pieces over multiple days.

Statement 2 is TRUE: The $1.20 bid-ask spread on a $25 stock equals 4.8%, which is very wide compared to liquid large-cap stocks (typically 0.01% to 0.10% spreads). This wide spread creates immediate transaction costs—buying at the ask and immediately selling at the bid would result in a 4.8% loss before any price movement. These costs significantly impact returns.

Statement 3 is TRUE: With only 15,000 shares trading daily, exiting the 5,000-share position later could be challenging, especially if the client needs funds quickly. The same volume constraints that affect buying also affect selling. If the client has liquidity needs, this illiquid security may be unsuitable.

Statement 4 is FALSE: The share price ($25) provides no information about valuation or suitability. Price per share is arbitrary—a stock can trade at $5, $25, or $500 regardless of whether it's undervalued, fairly valued, or overvalued. Suitability depends on the client's risk tolerance, time horizon, and liquidity needs, not the nominal share price. The low volume and wide spread are suitability concerns, not the price level.