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Everything there is to know about Bid and Ask

 

 

What Is the Difference Between Bid and Ask?

The phrase "bid and ask" (sometimes "bid and offer") refers to a two-way price quote that represents the best prospective price at which a security may be sold and acquired at a specific point in time. The bid price is the most a buyer is willing to pay for a share of stock or other security. The ask price is the lowest amount a seller is prepared to accept for the same security. When a buyer in the market is willing to pay the greatest offer available - or when a seller is willing to sell at the highest bid - a trade or transaction happens. The spread, or the gap between bid and ask prices, is a significant measure of an asset's liquidity. In general, the lower the spread, the higher the liquidity.


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Important points about Bid and Ask

 

 

Understanding the Terms Bid and Ask

The bid-ask spread is an inferred cost of trading for the ordinary investor. For example, if the current price quote for ABC Corp. stock is $10.50 / $10.55, investor X would pay $10.55 to acquire A at the current market price, while investor Y would receive $10.50 to sell ABC shares at the current market price.

Who Stands to Gain from the Bid-Ask Spread?

The bid-ask spread works in favour of the market maker. Continuing with the previous example, a market maker stating a price of $10.50 / $10.55 for ABC stock is signalling a desire to purchase A at $10.50 (the bid price) and sell it at $10.55 (the ask price) (the asked price). The spread indicates the profit of the market maker. The bid-ask spread can vary greatly depending on the asset and market. Blue-chip businesses in the Dow Jones Industrial Average may have a bid-ask spread of only a few cents, but a small-cap company trading fewer than 10,000 shares per day may have a bid-ask gap of 50 cents or more. During instances of illiquidity or market instability, the bid-ask spread can widen considerably because buyers will not be prepared to pay a price beyond a particular threshold, and sellers may not be willing to take prices below a certain level.

What Is the Distinction Between a Bid and an Ask Price?

The highest price that traders are ready to pay for a security is referred to as the bid price. The ask price, on the other hand, refers to the lowest price at which the security's owners are ready to sell it. If, for example, a stock is trading with an ask price of $20, a buyer would need to offer at least $20 in order to purchase it at today's price. The bid-ask spread refers to the difference between the bid and ask prices.

What Does It Mean When the Bid and the Ask Are Closely Spaced?

When the bid and ask prices are fairly close, it usually indicates that the security has plenty of liquidity. The security is considered to have a "narrow" bid-ask spread in this circumstance. This circumstance can be beneficial to investors since it makes it simpler to join and exit holdings, especially large ones. Securities with a "broad" bid-ask spread, or where the bid and ask prices are widely apart, on the other hand, can be time-consuming and costly to trade.

What Factors Influence Bid and Ask Prices?

The market determines bid and ask prices. They are determined, in particular, by the actual purchasing and selling choices of the people and institutions who invest in that asset. If demand exceeds supply, the bid and ask prices will steadily rise. In contrast, if supply exceeds demand, bid and ask prices would fall. The difference between bid and ask prices is controlled by the general amount of trading activity in the securities, with increased activity resulting in narrower bid-ask spreads and vice versa.

What Exactly Is a Bid-Ask Spread?

A bid-ask spread is the amount by which the ask price for an asset in the market exceeds the bid price. The bid-ask spread is the difference between the highest price a buyer is prepared to pay and the lowest price a seller is ready to accept for an item. A person seeking to sell will be paid the bid price, while a person looking to purchase will pay the ask price.

 

 

Bid-Ask Spreads Explained

A security's price represents the market's view of its worth at any given time, and it is unique. To understand why there is a "bid" and a "ask," consider the two main parties in each market transaction: the price taker (trader) and the market maker (counterparty).

Market makers, many of whom are hired by brokerages, offer to sell assets at a set price (the ask price) and will also bid to buy securities at a set price (the bid price) (the bid price). When an investor makes a deal, he or she will accept one of these two prices depending on whether they want to purchase (ask price) or sell (bid price) (bid price).

The spread is the primary transaction cost of trading (apart from fees), and it is collected by the market maker via the natural flow of processing orders at the bid and ask prices. This is what financial brokerages mean when they say their profits come from traders "crossing the spread."

The bid-ask spread may be thought of as a measure of supply and demand for a certain item. Because the bid indicates demand for an item and the ask represents supply, when these two values diverge, the price action reflects a shift in supply and demand.

The depth of the "bids" and "asks" can have a large influence on the bid-ask spread. If fewer players make limit orders to purchase an asset (resulting in lower bid prices) or fewer sellers place limit orders to sell, the spread may widen dramatically. As a result, while setting a purchase limit order, it's crucial to keep the bid-ask spread in mind to guarantee it executes effectively.

Market makers and experienced traders who foresee approaching risk in the markets may also increase the spread between their best bid and best ask at any given time. If all market makers do this on a particular asset, the quoted bid-ask spread will be greater than usual. Some high-frequency traders and market makers try to profit from variations in the bid-ask spread.

The Relationship Between the Bid-Ask Spread and Liquidity

The amount of the bid-ask spread fluctuates from one asset to the next according to the liquidity of each asset. The bid-ask spread is often used as a proxy for market liquidity. Certain markets are more liquid than others, and their smaller spreads should reflect this. Transaction initiators (price takers) require liquidity, whereas counterparties (market makers) supply liquidity.

Currency, for example, is considered the most liquid asset in the world, with one of the narrowest bid-ask spreads (one-hundredth of a percent); in other words, the spread may be measured in fractions of cents. Less liquid assets, such as small-cap stocks, on the other hand, may have spreads equal to 1% to 2% of the asset's lowest ask price.

Bid-ask spreads can also represent a market maker's estimated risk in making a deal. Options or futures contracts, for example, may have bid-ask spreads that are a substantially bigger percentage of their price than a currency or stocks deal. The spread's breadth may be determined not just by liquidity but also by how rapidly prices can fluctuate.

Example of a Bid-Ask Spread

If the bid price for a stock is $19 and the ask price is $20, the bid-ask spread for the stock in question is $1. The bid-ask spread may also be expressed as a percentage; it is often computed as a percentage of the lowest sale or ask price.

The bid-ask spread in percentage terms for the stock in the preceding example would be computed as $1 divided by $20 (the bid-ask spread divided by the lowest ask price), yielding a bid-ask spread of 5% ($1 / $20 x 100). If a possible buyer offered to buy the stock at a higher price or a potential seller offered to sell the shares at a lower price, this spread would close.

Bid-Ask Spread Elements

Bid-ask spread transactions may be done in most types of securities, as well as foreign exchange and commodities. The bid-ask spread is used by traders to gauge market liquidity. A high level of friction between supply and demand for that security will result in a greater spread. Most traders favour limit orders over market orders because they allow them to set their own entry locations rather than accepting the prevailing market price. Because two deals are taking place at the same time, the bid-ask spread incurs a cost.

What Is the Bid-Ask Spread?

A bid-ask spread is the difference between the asking and offering prices of a securities or other asset in financial markets. The bid-ask spread is the difference between the greatest price a buyer is willing to give (the bid price) and the lowest price a seller is willing to take (the ask price) (the ask price). An item with a small bid-ask spread is likely to be in strong demand. Assets with a broad bid-ask spread, on the other hand, may have a low level of demand, causing larger price differences.

What Causes a Wide Bid-Ask Spread?

A wide bid-ask spread, often known as "spread," can occur owing to a variety of circumstances. First and foremost, liquidity is critical. The spread will be narrower when there is a substantial level of liquidity in a certain market for a securities. Stocks with a high volume of trading, such as Google, Apple, and Microsoft, will have a narrower bid-ask spread. On the other hand, a bid-ask spread may be wide for unfamiliar or unpopular assets on a particular day. Small-cap companies, for example, may have smaller trading volumes and a lower degree of investor demand.

What Is an Example of a Stock Bid-Ask Spread?

Consider the following scenario: a trader wants to buy 100 shares of Apple for $50. The trader notices that 100 shares are being offered on the market for $50.05. The spread in this case would be $50.00 - $50.05, or $0.05 wide. While this spread may appear little or trivial, it may make a big impact on large trades, which is why narrow spreads are often preferred. In this case, the entire value of the bid-ask spread would be equal to 100 shares x $0.05, or $5.

Demand and Supply

Before understanding about the spread, investors must first comprehend the notion of supply and demand. The amount or quantity of a certain commodity in the marketplace, such as the supply of stock for sale, is referred to as supply. The readiness of an individual to pay a specific price for an item or stock is referred to as demand. As a result, the bid-ask spread indicates the levels at which buyers will purchase and sellers will sell. A narrow bid-ask spread might suggest that an asset is actively traded and has strong liquidity. A broad bid-ask spread, on the other hand, may suggest the inverse. The bid-ask spread will widen significantly if there is a severe supply or demand imbalance and poor liquidity. As a result, popular securities (e.g., Apple, Netflix, or Google shares) may have a reduced spread, whereas a stock that is not often traded may have a bigger spread.

An Illustration of the Bid-Ask Spread

The spread is the difference between the bid and ask prices for a specific securities.

Assume Morgan Stanley Capital International (MSCI) wants to buy 1,000 shares of XYZ stock at $10 per share and Merrill Lynch wants to sell 1,500 shares for $10.25 per share. The spread is the difference, or 25 cents, between the asking price of $10.25 and the bid price of $10.

An individual investor looking at this spread would know that if they wanted to sell 1,000 shares, they could do so for $10 if they sold to MSCI. In contrast, the same investor would be aware that they could buy 1,500 shares from Merrill Lynch for $10.25.

Supply and demand affect the magnitude of the spread and the stock price. The more individual investors or corporations who wish to purchase, the more bids there will be, and the more sellers, the more offers or requests there will be.

Obligations for Orders Placed

When a company posts a high bid or ask and is struck with an order, it must honour its posting. In other words, in the above example, if MSCI puts the highest offer for 1,000 shares of stock and a seller submits an order to sell 1,000 shares to the firm, MSCI is obligated to honour its bid. The same may be said about ask pricing.

In summary, the bid-ask spread always works against the ordinary investor, whether they are buying or selling. The price disparity, or spread, between the bid and ask prices is defined by the total supply and demand for the investment asset, which influences its trading liquidity.

In terms of the bid-ask spread, the major factor for an investor considering a stock purchase is simply how confident they are that the stock's price will climb to a point where it will have greatly surmounted the impediment to profit that the bid-ask spread creates. Consider the case of a stock with a bid price of $7 and an ask price of $9.

If the investor buys the stock, it will have to rise to $10 per share just to make a $1 per-share profit for the investment. However, if the investor believes that the stock is likely to rise to a price of $25 to $30 per share, they anticipate the shares to generate a very big profit over the $9 per-share offer price that must be paid to purchase the stock.

Order Varieties

A person can place five different sorts of orders with a specialist or market maker:

Market Order - A market order is one that may be completed at the current market or prevailing price. Using the previous example, if the buyer placed an order to purchase 1,500 shares, the buyer would get 1,500 shares at the asking price of $10.25. If they placed a market order for 2,000 shares, the buyer would receive 1,500 at $10.25 and 500 at the next best offer price, which may be higher than $10.25.

Limit Order - A limit order is placed by a person to sell or purchase a specific amount of shares at a specific price or better. Using the aforementioned spread as an example, a person may place a limit order to sell 2,000 shares at $10. When such an order is placed, the individual will instantly sell 1,000 shares at the current offer price of $10. They may then have to wait until another customer comes along and bids $10 or more to satisfy the remainder of the order. Again, the remaining stock will not be sold unless the shares trade at $10 or above. If the stock remains below $10 a share, the seller may never be able to sell it.

Day Order - A day order is valid just for that trading day. The order is cancelled if it is not filled that day.

Fill or Kill (FOK) - An FOK order must be filled quickly and completely, or it will be ignored. For example, if a person places a FOK order to sell 2,000 shares at $10, a buyer will either accept all 2,000 shares at that price right away or deny the order, in which case it will be cancelled.

Stop Order - A stop order is activated when the stock price reaches a specific threshold.

Assume an investor wishes to sell 1,000 shares of XYZ company if it falls below $9. In this example, the investor may set a stop order at $9 so that the order becomes effective as a market order if the stock trades to that level. To be clear, this does not ensure that the order will be filled at the exact price of $9, but it does guarantee that the stock will be sold. If there are a lot of vendors, the price at which the order is filled might be significantly lower than $9.

What do the bid and ask prices on a stock quote represent?

Bid and ask prices are market terminology that indicate a stock's supply and demand. The bid is the most money someone is ready to pay for a share. The ask is the lowest price at which a share can be sold. The spread is the difference between the bid and ask price. The stated price of a stock is the most recent sale price.

How Is the Spread Matched?

A computer can match a buyer and seller on the New York Stock Exchange (NYSE). In other cases, however, a professional who deals with the stock in issue will connect buyers and sellers on the trading floor. In the absence of buyers and sellers, this individual will post bids or offers for the stock to keep the market orderly.

A market maker on the Nasdaq will employ a computer system to post bids and offers, basically serving the same function as a specialist. There is, however, no real floor. All orders are electronically tagged.

Making a Deal

An investor places an order with their broker to initiate a deal. The trade mechanisms differ based on the type of order placed. The normal procedure, however, is brokers making an offer to a stock exchange. Each offer to acquire specifies the number of shares sought as well as the suggested purchase price. The bid indicates the demand side of the market for a certain stock and is the highest proposed buying price.

Each offer to sell comprises a quantity offered as well as a recommended sale price. The lowest recommended selling price is known as the ask, and it reflects the supply side of the market for a particular asset. If an existing ask matches an existing bid, an order to purchase or sell is filled.

There will be no trades between brokers if no orders bridge the bid-ask spread. To keep markets running smoothly, organisations known as market makers quote both the bid and ask prices when no orders cross the spread.

Consider the hypothetical Company ABC, which has a current best bid of $9.95 for 100 shares and a current best ask of $10.05 for 200 shares. A transaction does not take place unless a buyer meets the ask or a seller meets the bid.

Assume a market order is placed by an investor to purchase 100 shares of Company ABC. The offer price would change to $10.05, and the shares would trade until the order was filled. Once these 100 shares are traded, the bid will revert to the next highest bid order, which in this case is $9.95.

 

 

What Factors Influence a Stock's Bid-Ask Spread?

The bid-ask spread is a fundamental concept in investing that may be applied to many aspects of a person's financial life, such as purchasing a home or a car. It may also be used to bargain for stock purchases.

The bid-ask spread is quite essential in the market. It is the difference between the buyer's and seller's prices - or what the buyer is willing to pay for something against what the seller is willing to get to sell it.

The Effect of Liquidity on Bid-Ask Spreads

The discrepancy between the bid and ask prices is influenced by a number of things. The most obvious consideration is the liquidity of a security. This refers to the daily volume or number of shares traded. Some stocks are traded often, while others are traded just a few times each day.

Stocks and indices with high trading volumes will have smaller bid-ask spreads than those with low trading volumes. A stock is deemed illiquid when it has a low trading volume because it cannot be easily converted to cash. As a result of the wider spread, a broker will demand more money for completing the transaction.

Bid-Ask Spreads and Volatility

Volatility is another major factor that influences the bid-ask spread. During instances of fast market fall or development, volatility typically rises. The bid-ask spread is substantially greater at these times because market makers seek to take advantage of and profit from it. When the value of a security rises, investors are ready to pay more, allowing market makers to demand larger premiums. The bid-ask spread is small when volatility is low and uncertainty and risk are low.

Stock Price Influence

The bid-ask spread is also influenced by the price of a stock. When the price is low, the bid-ask spread is often wider. The explanation for this has to do with the concept of liquidity. The majority of low-cost securities are either new or modest in size. As a result, the amount of these securities available for trading is limited, making them less liquid.

Finally, the bid-ask spread is determined by supply and demand. That is, a lower spread will result from more demand and tighter supply. Finding a buyer or seller may now be done considerably more quickly thanks to technological advances, making supply-and-demand dynamics much more efficient.

When a customer or seller wants to make an order, they have a number of options. This contains a market order, which indicates that the party will accept the best offer. Then there's a limit order, which specifies the maximum price one is ready to pay to complete the deal. A limit order will only be filled if the price specified is available. Meanwhile, a stop order is a conditional order that transforms into a market or limit order when a certain price is met. It cannot be viewed by the market unless it is put, as opposed to a limit order, which can be seen when it is placed.

The bid-ask spread may reveal a lot about a security, therefore you should be aware of all the factors that contribute to the bid-ask spread of a security you are interested in. Your investing approach and the amount of risk you are prepared to take may influence the bid-ask spread you consider acceptable.

 

 

The bid-ask spread is essentially an ongoing dialogue

In general, the spread between bid and ask prices indicates a sort of bargaining between two parties - the buyer and seller. There are several elements that might influence how wide or tight the gap between the ask and bid price is. Understanding the various elements allows investors to make better educated investment decisions and minimise their risk.

The bid-ask spread is essentially an ongoing dialogue. To be successful, traders must be ready to take a stance and exit the bid-ask process using limit orders. Traders that execute a market order without regard for the bid-ask spread or without insisting on a limit are basically confirming another trader's bid, resulting in a profit for that trader.

Stock exchanges are established to help brokers and other professionals coordinate bid and ask prices. The bid price is the amount a buyer is willing to pay for a certain security, whereas the asking price is the amount a seller is ready to accept for same security.

If the prices are near, it indicates that the two parties have the same viewpoint. If, on the other hand, the price difference is significant, it indicates that they do not see eye to eye.

In fact, however, the asking price is always somewhat more than the bid price. The bid-ask spread is the difference between the bid and ask prices. This difference is a profit for the broker or expert managing the transaction.

This spread essentially shows the supply and demand for a certain item, such as stocks. Bids represent demand, while ask prices reflect supply. When one outweighs the other, the spread might grow considerably broader.

 

Source: Investopedia

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Arpita SinghArpita Singh is the main writer at ForexBroker.ae. As a senior investment professional with 10+ years of experience working at top-tier Private Equity and Sovereign Wealth Fund; she is also responsible for fact-checking concepts, reviews, and related details about brokers and exchanges listed on this website. Full Bio.