Understanding Liquidity in Prediction Markets

You find a market mispriced by 10 cents. Easy money, right?

You place your order. The price moves 8 cents against you before you’re filled. Your 10-cent edge became a 2-cent edge.

That’s liquidity - or rather, the lack of it.

Understanding liquidity is the difference between theoretical profits and actual profits. Most beginners ignore it and wonder why their returns don’t match their backtests.

Let me explain what liquidity really means and how to use it to your advantage.

What Is Liquidity?

Liquidity measures how easily you can buy or sell without moving the price.

High liquidity: Large orders execute at expected prices. Tight spreads. Deep order books.

Low liquidity: Even small orders move prices. Wide spreads. Thin order books.

In a perfectly liquid market, you can trade any size instantly at the current price. In reality, no market is perfectly liquid. The question is: how close is it?

The Order Book Explained

Prediction markets use order books, just like stock exchanges.

On one side: Buyers listing prices they’ll pay. These are “bids.”

On the other side: Sellers listing prices they’ll accept. These are “asks.”

The gap between the best bid and best ask is the “spread.”

Example order book:

ASKS (Sellers)
$0.55 - 1,000 shares
$0.54 - 500 shares
$0.53 - 2,000 shares

BIDS (Buyers)
$0.50 - 1,500 shares
$0.49 - 800 shares
$0.48 - 3,000 shares

If you want to buy immediately, you pay $0.53 (the best ask). If you want to sell immediately, you get $0.50 (the best bid).

The spread is 3 cents. That’s your transaction cost beyond any explicit fees.

Why Spread Matters

Every trade you make crosses the spread. If you buy at 53 and need to sell at 50 just to exit flat, you’ve already lost 3 cents.

For a trade to be profitable, the price needs to move in your favor by more than the spread (plus fees).

In our example:

• You buy at 53 cents
• You need the price to go above 56 cents (53 + 3 spread) just to break even
• Any profit only starts above 56

Wide spreads kill edge. A market trading at “fair value” with a 6-cent spread isn’t tradeable. You’d need a 6+ cent edge just to break even.

Slippage: The Hidden Cost

Slippage is what happens when your order is larger than the available liquidity at the best price.

Back to our order book:

ASKS (Sellers)
$0.55 - 1,000 shares
$0.54 - 500 shares
$0.53 - 2,000 shares

If you want to buy 2,000 shares, you get all of them at $0.53. Great.

If you want to buy 3,000 shares:

• 2,000 at $0.53
• 500 at $0.54
• 500 at $0.55

Your average price is $0.535, not $0.53. That extra half cent is slippage.

For large orders, slippage can be significant. The price you see isn’t the price you get.

How to Assess Market Liquidity

Before trading any market, check three things:

1. The spread

Tighter is better. Under 2 cents is great. 2-5 cents is workable. Above 5 cents, you need a really strong edge.

2. Order book depth

How many shares are available at each price level? If there’s only $100 at the best price, any meaningful order will eat through multiple levels.

3. Daily volume

How much is trading? High-volume markets (millions daily) are more liquid than low-volume markets (thousands daily).

Both Polymarket and Kalshi show this information. Learn to read it before placing orders.

Finding Liquid Markets

Not all prediction markets are created equal. Liquidity concentrates in:

Major political events. Presidential elections, key votes, Supreme Court decisions. These attract the most attention and capital.

High-profile sports. NFL playoffs, major tennis tournaments, championship games. Casual bettors pile in.

Imminent resolutions. Markets resolving within days or weeks are more liquid than those resolving in months. Traders want to deploy capital where it’ll be freed up soon.

Breaking news. When something’s trending, liquidity floods in. Trade while the attention lasts.

Avoid:

Obscure markets. That random question about a county election nobody’s heard of? Probably thin.

Far-future resolutions. Will X happen in 2030? Maybe. But liquidity is locked up for years. Most traders avoid these.

Complex multi-part questions. The more specific and conditional a market is, the fewer people understand it and trade it.

Practical Liquidity Strategies

Strategy 1: Use limit orders

Market orders execute immediately at whatever price is available. Limit orders execute only at your specified price or better.

For illiquid markets, always use limits. You control your execution price and avoid getting ripped by thin order books.

Trade-off: Limit orders might not fill. If the price moves away from your limit, you miss the trade.

Strategy 2: Scale in and out

Instead of one big order, break it into smaller pieces. Buy some now. Wait. Buy more if the price holds.

This reduces market impact. You’re not eating through the order book all at once.

Strategy 3: Provide liquidity instead of taking it

Instead of hitting existing orders (taking liquidity), place your own orders and wait for others to hit you (providing liquidity).

If the market is 50 bid / 53 ask, place a buy order at 51. You’re offering a better price than existing bids. If someone wants to sell, they’ll hit you instead of the 50 bid.

You get a better price. Trade-off: The order might not fill.

Strategy 4: Time your entries

Liquidity isn’t constant. It peaks during news events, market opens, and when resolution approaches.

Trading during high-liquidity periods means better execution. Trading during low-liquidity periods (weekends, off-hours) often means worse fills.

Cross-Platform Liquidity

Same market on different platforms can have very different liquidity.

Political markets often have deeper liquidity on Polymarket. Sports markets often have deeper liquidity on Kalshi. Economics and weather might be better on Kalshi.

Before you trade, check both platforms. If Polymarket has a 2-cent spread and Kalshi has a 5-cent spread for the same outcome, trade on Polymarket.

This also creates arbitrage opportunities. If prices differ between platforms, you can buy on one and sell on the other. But that’s a different strategy.

Liquidity and Position Sizing

Here’s a rule most beginners ignore:

Never size a position larger than you can exit without significant slippage.

If a market has $10,000 of liquidity on the order book, don’t take a $15,000 position. You literally can’t exit without crushing the price.

Rule of thumb: Keep your position under 10-20% of daily volume. If a market does $50,000 daily, limit yourself to $5,000-10,000 positions.

For thinner markets, even smaller. If daily volume is $5,000, your position should be $500-1,000 max.

When Illiquidity Is Opportunity

Low liquidity isn’t always bad. Sometimes it creates opportunities.

Finding mispriced thin markets

Less competition means more mispricings. If you find a thin market trading at 40 cents that you’re confident should be at 60 cents, the low liquidity might be why it’s mispriced.

You can take a small position and profit if you’re right. Just size appropriately.

Providing liquidity

In thin markets, providing liquidity can be very profitable. If you’re the only one offering decent prices, everyone has to trade through you.

Market makers do this professionally. You can do it manually in markets you understand well.

Time-based arbitrage

Thin markets adjust slowly to news. If you see news that should move a market, but the thin market hasn’t adjusted yet, you can capture that lag.

The same news in a liquid market would be arbitraged away in seconds. In a thin market, you might have minutes.

Tracking Liquidity Over Time

Liquidity changes. A market that’s thin today might become liquid tomorrow if it becomes newsworthy.

Keep a watchlist of markets you want to trade. Monitor their liquidity regularly. When a thin market becomes liquid, that might be your entry signal.

Also watch for liquidity disappearing. As resolution approaches and the outcome becomes obvious, liquidity often dries up. Get out before everyone else heads for the exit.

Red Flags to Avoid

Massive spread on simple questions

If a binary yes/no question has a 10-cent spread, something’s wrong. Either no one cares about this market, or there’s some resolution risk the market is pricing in.

Ghost liquidity

Sometimes order books show lots of shares, but they disappear when you try to trade. This is spoofing - fake orders meant to manipulate perception of liquidity.

Test with small orders first if you’re suspicious.

Sudden liquidity evaporation

If a liquid market suddenly becomes thin, pay attention. Informed traders might know something about resolution risk or rule changes.

The Bottom Line

Liquidity is the invisible cost of trading. Ignore it and your theoretical edges disappear into slippage and spreads.

Before every trade, ask:

1. What’s the spread? Is my edge bigger than the spread?
2. How much can I trade without moving the price?
3. If I need to exit quickly, can I?

Learn to read order books. Use limit orders. Size positions appropriately. Trade liquid markets unless you have a specific reason to trade thin ones.

The traders who consistently profit are the ones who account for execution quality, not just directional predictions.

Liquidity awareness isn’t sexy. But it’s what separates amateurs from professionals.