Illiquid Stocks are Stocks That are Thinly Traded on the Exchanges. What this means is that the volume in these stocks are very low.
Let's give you an example. Stocks that form a part of the Sensex and the Nifty are traded in heavy volumes. For example, several lakhs of shares of Reliance Industries change hands everyday making it a very liquid stock.
Why Illiquid Stocks Can be dangerous?
Illiquid stocks can be dangerous to buy because they can be very volatile. A small buy quantity can lead to a big spike in the share price, while a small sell quantity can lead to a virtual collapse in the stock price.
What also happens is that you can get trapped with illiquid stocks if you have large quantities that cannot be sold. Let's say that you had purchased a large quantity of around 10,000 shares of any illiquid stock. Since there are no buyers for these you may not be able to offload the entire number at the same time. What this means is that if you urgently need money, you may not be able to sell all your shares at one go. You would have to sell the 10,000 shares on a piecemeal basis.
Another problem for illiquid stocks is that mutual funds, domestic institutions and other top market players never buy these stocks. Since these are illiquid they are never touched by these set of institutions.
It's never easy to say which stocks will suddenly turn illiquid. Generally, the company's who are not doing well, will have their stocks turn illiquid. As these company start to recover and do well, we will suddenly see a demand for these stocks. It's best to avoid these stocks as they can be volatile and leave you trapped with no exit option.