Bid-Ask Spread
The bid-ask spread is the difference between the highest price a buyer is willing to pay (bid) and the lowest price a seller is willing to accept (ask), representing a transaction cost and liquidity indicator.
Exam Tip
Bid = what buyers pay (lower). Ask = what sellers want (higher). Spread = transaction cost. Wider spread = less liquid.
What is the Bid-Ask Spread?
The bid-ask spread is the gap between what buyers want to pay and what sellers want to receive. It's a fundamental concept in securities trading that affects every transaction.
Key Terms
| Term | Definition |
|---|---|
| Bid Price | Highest price buyers will pay |
| Ask Price | Lowest price sellers will accept |
| Spread | Ask price minus bid price |
| Mid Price | Average of bid and ask |
Example
| Price | |
|---|---|
| Ask (Offer) | $50.10 |
| Bid | $50.00 |
| Spread | $0.10 |
If you buy at $50.10 and immediately sell at $50.00, you lose $0.10 per share to the spread.
What Determines the Spread
| Factor | Effect on Spread |
|---|---|
| High liquidity | Narrow spread |
| Low liquidity | Wide spread |
| High volatility | Wider spread |
| Market hours | Narrower during regular hours |
| Stock price | Higher prices often = wider spreads |
Who Profits from the Spread
- Market makers profit from the spread
- Dealers buy at bid, sell at ask
- The spread compensates for inventory risk
Spread as a Cost
The bid-ask spread is a hidden transaction cost:
- Round-trip cost: You pay spread twice (buy and sell)
- Impact on returns: Especially significant for frequent traders
- Why it matters: Tighter spreads = lower trading costs
Spread Width Examples
| Security Type | Typical Spread |
|---|---|
| Large-cap stocks (AAPL) | $0.01 - $0.05 |
| Small-cap stocks | $0.10 - $0.50 |
| ETFs (SPY) | $0.01 - $0.02 |
| OTC stocks | $0.25 - $1.00+ |
| Government bonds | Very tight |
| Corporate bonds | Wider |
Limit Orders vs. Market Orders
- Market order: Executes at current bid/ask (pays the spread)
- Limit order: Sets your price, may not execute but can avoid paying full spread
Study This Term In
Related Terms
Liquidity
SecuritiesLiquidity refers to how quickly and easily an asset can be converted to cash without significantly affecting its price. Cash is the most liquid asset, while real estate and collectibles are considered illiquid.
Market Maker
SecuritiesA market maker is a broker-dealer firm that stands ready to buy and sell a particular security at publicly quoted prices, providing liquidity to the market by maintaining bid and ask prices throughout the trading day.
Market Order
SecuritiesA market order is an instruction to buy or sell a security immediately at the best available current price, guaranteeing execution but not the price.
Limit Order
SecuritiesA limit order is an instruction to buy or sell a security at a specified price or better, guaranteeing the price but not guaranteeing execution.