What is the Bid-Ask Spread?
Bid-Ask Spread Example
Let's assume you are watching Company XYZ's stock. If the bid price is $50 and the ask price is $51.50, then the bid-ask spread is $1.50. Typically, a trader or specialist on the floor of the New York Stock Exchange would quote the bid-ask spread as follows:
50-51-1/2 100x50 100,000
The last number (100,000) denotes the number of Company XYZ shares traded since the market opened. Note that online trading systems might refer to the bid-ask spread as "BxA."
There may be several bid prices and several ask prices for a security at any point in time. However, only the best bid (that is, the highest price offered for a security) and the best ask (that is, the lowest price asked for a security) are used to calculate the bid-ask spread.
Note that the number of shares wanted and the number of shares offered for sale may be different. This means that an investor may only be able to purchase 5,000 of a desired 10,000 XYZ Company shares at $51.50 if there are only 5,000 shares for sale at that price.
Why the Bid-Ask Spread Matters
It is important to remember one key aspect of bid and ask prices: purchasers pay the ask price and sellers receive the bid price. This nuance is why securities dealers make a profit on bid-ask spreads. Their job is to buy stocks at the bid price and sell at the ask price. Thus, the size of the bid-ask spread is proportional to the size of the dealer's profit (although not all of the spread constitutes profit for the dealer, other fees are part of the spread). Dealer profit is also one reason illiquid or lightly traded stocks tend to have larger spreads than frequently traded stocks.
Many traders and analysts scrutinize patterns in bid-ask spreads to understand what prices trigger demand for both sellers and buyers. Other traders and analysts feel that the bid-ask spread itself has little predictive value.
Personalized Financial Plans for an Uncertain Market
In today’s uncertain market, investors are looking for answers to help them grow and protect their savings. So we partnered with Vanguard Advisers -- one of the most trusted names in finance -- to offer you a financial plan built to withstand a variety of market and economic conditions. A Vanguard advisor will craft your customized plan and then manage your savings, giving you more confidence to help you meet your goals. Click here to get started.
Read This Next
Traders find success along many paths, but most follow discretionary or systemic trading rules. Discretionary traders buy and sell based upon what they think is going to happen in the markets....Read More →
Calculating Internal Rate of Return (IRR) can be tedious if you have ...Read More →