Primary market liquidity is something mutual fund investors are likely familiar with. This liquidity pool is facilitated by the creation & redemption of ETF shares. When investors purchase a mutual fund, the transaction is settled with a creation of new mutual fund shares. In the primary market for an ETF, shares are created & redeemed with this same mechanism. The key difference is that investors have the flexibility to access these shares intra-day with an ETF versus just the end of day with a mutual fund. Investors can access primary market liquidity by simply phoning their broker for a block trade.
Secondary market liquidity is something that equity investors are familiar with. This is the on-exchange trading activity of an ETF. The vast majority of U.S. ETFs are listed on NYSE Arca, and trade during U.S. hours across U.S. exchanges. Numerous liquidity providers actively participate in ETF markets by quoting shares on these exchanges. This allows for investors to purchase or sell shares by simply placing an order with their broker.
A common misconception is that secondary market liquidity is a constraint on daily trading volume in an ETF. In fact it is quite common to see trades in many multiples of average daily volume executed with no impact on the market. This is due to the deep primary market liquidity in ETFs, as investors have access to primary market ETF shares.