What is the Bid-Ask Spread?

What is the Bid-Ask Spread?

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Today we are going to know in this article, What is the Bid-Ask Spread?

What is the Bid-Ask Spread?

The Bid-Ask Spread is the difference between the prices quoted for an immediate sell and an immediate buy for stocks, futures contracts, options, or currency pairs. The size of the bid-ask spread in a security is a measure of the size of the market’s liquidity and transaction costs.

The price of a stock is the market’s understanding of its value at any given time and is specific. To understand the reason why there is a “bid” and “ask” in every market transaction, there must be two main players, namely the price taker (trader) and the market maker (counterparty).

Bid-Ask Spread

The bid-ask spread can be used as a measure of supply and demand for a given commodity. Since the bid can be said to represent demand and the offer to represent supply for a commodity, it may be possible that market action represents a change in supply and demand as these two prices are different.

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The depth of “offers” and “asks” can have a big impact on the bid-ask spread. The spread can be quite wide if fewer participants place limit orders to buy the security (thus generating a lower bid price) or if fewer sellers place limit orders to sell. As such, when placing a buy limit order taking into account the bid-ask it is important to ensure that it is executed successfully.

Definition of “Bid-Ask Spread” :-

The bid-ask spread is usually the difference between the ask (offer/sell) price and the bid (buy) price of a security. Ask price is the price point at which seller is ready to sell and Bid price is the point at which buyer is ready to buy. A trade occurs when two price points in the market match, ie when a buyer and a seller agree to the prices being offered by each other.

These prices are determined by two market forces – demand and supply, and the difference between these two forces defines the spread between the buy-sell prices. The bigger the distance, the bigger the spread! The bid-ask spread can be expressed in absolute terms and as a percentage. Spread values ​​can be very small when the market is highly liquid, but they can be large when the market is liquid or less liquid.

Formula of Bid-Ask Spread

What causes the bid-ask spread to be high?

The bid-ask spread, also known as the spread, can be high due to a number of factors. First, liquidity plays a primary role. When there is a sufficient amount of liquidity in a given market for a security, the spread will be hardening. Stocks that are heavily traded, such as Google, Apple, and Microsoft, will have a smaller bid-ask spread.

Conversely, a bid-ask spread may be high for unknown, or unpopular securities on some day. These may include small-cap stocks, which may have low trading volumes, and a low level of demand among investors.

What is an example of a bid-ask spread in a stock?

Consider the following example where a trader wants to buy 100 shares of Apple for Rs 50. The trader observes that 100 shares are being offered in the market at Rs 50.05. Here, Spread Rs. 50.00 – Rs.50.05, or Rs.0.05 wide.

While this spread may seem small or insignificant, on larger trades, it can make a meaningful difference, which is why narrower spreads are usually more ideal. In this example, the total value of the bid-ask spread would be equal to 100 shares x Rs.0.05, or Rs.5.

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