What Is a Bid-Ask Spread?
The bid-ask spread is the gap between what buyers are willing to pay (the bid) and the lowest price sellers will accept (the ask) for an asset in the market. When you sell, you get the bid price, and when you buy, you pay the ask price.
How Bid-Ask Spreads Work
A stock’s price shows what the market thinks it’s worth at any time. The bid is what buyers are ready to pay, and the ask is what sellers will settle for. Market makers from brokerage firms set these prices. They make their money off the spread – that’s the main cost of trading, besides commissions. This spread also shows how much people want the asset – the bid shows the demand, and the ask shows the supply.
The bid-ask spread changes based on how many people are buying or selling. If not many are buying (few bids) or selling (few asks), the spread gets wider. Market makers might also widen this spread if they think the market’s about to move a lot.
Bid-Ask Spread and Liquidity
The size of the bid-ask spread depends on the asset’s liquidity – that’s a measure of how easy it is to trade it without affecting its price. More liquid assets, like major currencies, have tiny spreads. Less liquid things, like small company stocks, have wider spreads.
The spread also shows how risky market makers think an asset is. Riskier trades, like options or futures, might have wider spreads than stocks or currencies.
Bid-Ask Spread Example
If a stock’s bid is $19 and the ask is $20, the spread is $1. To get this as a percentage, divide the spread by the ask price. So, $1 divided by $20 is a 5% spread. This spread gets smaller if a buyer raises their bid or a seller lowers their ask.
Using the Bid-Ask Spread
Most traders like to set the price they’re willing to pay or take – that’s using a limit order, not a market order which just takes the current price. The spread is a cost because you’re making two trades at once.
The bid-ask spread is a quick way to see how often an asset is traded – a small spread means it’s traded a lot, a big one means it’s not. Watching the spread can help you decide how to trade – whether you want to set your own price or take the market’s offer.