Clown fire
A civil war veteran known as "Tecomatio" participates in a protest outside the Salvadoran congress building to ask the approval of a civil war veterans benefits law in San Salvador, El Salvador, September 21, 2015.
REUTERS/Jose Cabezas
Volatile market conditions could get worse, a senior official from the International Monetary Fund is warning.

As oil plunges below $27 a barrel and equity markets sell off in panic, Zhu Min, the IMF's deputy director, says markets are becoming more fragile.

Market liquidity is the main concern. Prices move faster and further when investors make the same decisions at the same time.

"The key issue is that liquidity could drop dramatically, and that scares everyone," Min told a panel at the World Economic Forum in Davos, according to a report from Ambrose Evans-Pritchard in the Telegraph.

Markets work by matching up buyers and sellers at an agreed price. How quickly and easily they do that depends on the amount of liquidity in the market, which is determined by how many people are willing to buy and sell at that price.

If this liquidity dries up then prices can suddenly jump and it becomes harder to match people on both sides of a trade. For example, if everyone wants to sell BP, but no one will buy, the price will plummet. That's because people keep slashing the offer price to try and find a buying floor.

It's a consequence of herd behaviour. Liquidity in markets can fall when all investors are aligned in the same way and there are fewer people willing to take the other side of the crowd's buying or selling.

"If everybody is moving together we don't have any liquidity at all. We have to be ready to act very fast," Min said. "When rates go up, market valuations have to adjust."

In recent weeks, this theory of a liquidity crisis has crystalized in the reaction to the US Federal Reserve unwinding its near-zero interest rate policy. As the Fed begins to raise rates, so all global investors change their behaviour at the same time, in the same way, increasing the likelihood of big price moves and market volatility.