Does a market’s liquidity increase as more people trade?
Yes, Yes/No markets increase in liquidity as more people trade.
The house (Manifold Markets) injects M$20 into the liquidity pool after each new unique trader places a prediction. After a market has 100 unique traders it stops automatically receiving bonus liquidity.
The market’s liquidity can also increase if a user manually subsidises it.
Free response and multiple choice markets do not work in the same way and Manifold does not inject mana into the liquidity pool with each unique trader.
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Frequently asked question: why do my trades sometimes move the price a lot even on very high volume markets?
On Yes/No markets, past trades do not directly affect current liquidity. This is an example to help understand why intuitively: if M$100k has been traded between people, what that means is the market has effectively paired up a bunch of yes buyers and no buyers, and their shares are locked in. When you make a new trade, you have to be matched with someone else who is willing to trade with you right now (this is the automated market maker or limit orders) - and the previously invested M$100k has no way to influence that, because their shares can't be touched.
Now, Manifold does help by injecting more liquidity as more people trade, as described above, but this is not a direct consequence of the market mechanism - it’s Manifold expanding the liquidity pool that makes the market more liquid, not the fact that people hold a lot of shares.
Also note: this is exactly the same as how stock markets. People's intuition is that highly traded stocks have higher liquidity, but that is because more people are willing to offer trades, not because the past trades had any direct effect on current liquidity - same as it works on Manifold. Stock prices for big public companies can and do move a lot without a lot of money changing hands - for example, after they announce earnings.
On the other hand, free response and multiple choice markets use a different mechanism in which past trades do directly contribute to liquidity, and this is because when you trade you do not buy a specific number of shares, instead your investment is added to a pool.
