Liquidity refers to how easy it is to buy or sell an investment. For example, when you want to buy shares in a company, you usually place an order with your stockbroker, who then has to find somebody who wants to sell their shares so that a trade can take place. Conversely, if you want to sell, your broker needs to find a buyer for your shares.
This is rarely an issue if what you want to trade is a FTSE 100 stock, where millions of shares change hands every day. But it can be a problem if you invest in very small stocks, especially when you come to sell. At certain times, your broker may not be able to find a buyer without cutting the price significantly, potentially leaving you with heavy losses.
The level of liquidity in a market can vary greatly. During periods of market turmoil, it may dry up altogether, making it difficult to sell many securities that are normally very easy to trade. In the worst market panics, only “safe haven” government bonds, such as US Treasuries and UK Gilts, may remain as liquid as they usually are.