A quick read: What is liquidity, and how does it affect stock prices?

Liquidity is the availability of cash in the economy. it can be driven by multiple factors.

 
If the central bank is printing money and keeping interest rates low, there will be more cash in the economy, and vice versa.

The interest rate is a percentage charged by the lender on the borrower’s debt repayment or reward for saving money at the bank.

There is an inverse relationship between interest rates and liquidity.

Here's how liquidity affects stock prices: Stock prices are slaves to demand and supply.

I. If demand for a stock is greater than supply, its price will shoot up. This is because more people want to buy the shares, so they will have to compete among each other by offering higher and higher prices.

2. If supply for a stock is greater than demand, the stock price will collapse. This is because if very few people want to buy a share but a lot of people want to get rid of it (sell it), the sellers will have to compete among each other by offering lower prices to the buyers.

Now, how does liquidity affect demand and supply?

Higher liquidity in the economy means people have a lot of money in hand. 

The spending of this money will lead to economic growth, but this money will also be invested in the stock market, thereby increasing the prices of stocks. whereas lower liquidity in the economy means people do not have money to spend, let alone invest. So the demand for shares goes down. Instead, they might sell their investments to meet their basic needs, thereby driving up supply for the shares. This is why, following the economic shock, markets around the world soared.

This is why markets across the globe shot up post-COVID because of the availability of excess liquidity offered by low interest rates.

We saw bear markets globally when central banks started raising rates all over the world to fight inflation. Excess liquidity is the exact reason why all cryptocurrencies gave mind-boggling returns in 2020–21 and have been down 70–80% ever since the FED announced they were going to raise rates.

                                                                                                                  (Pic courtsey- Investopedia)