Discussion Topic: Bid-Ask Spread
Whether you are a Forex trader or a Stock trader, it is highly important that you know the concept of Bid-Ask Spread. The concept of Bid Price, Ask Price, and Spread is the basic foundation of both Forex trading and Stock trading. Understanding the concept of how the Bid/Ask Spread works can help you in making better trading strategy.
What is a Bid and Ask in Trading?
A bid is an offer of price made by a trader, a dealer, or an investor to buy a stock/share, commodity or currency. Especially in case of Forex Trading, a Bid is also referred as the price at which a market maker is willing to buy. A Market maker is a kind of broker and unlike a retail buyer, they also display an ask price.
Ask is the offer price at which seller is willing to sell a security, commodity, or currency. At a normal market condition, the Ask price will always be higher than the bid price.
What is Bid Price in Trading?
In both forex trading and stock trading, the bid price represents the highest value of buy order that is currently available on the market. This is the highest price that a trader or investor is willing to pay to go long (buy) at that moment.
When placing a bid order, there is no guarantee that the trader or investor placing the bid will get the full amount of shares or contracts or lots. For each of the transaction placed on the market, it requires a buyer (bidder) who is willing to buy and a seller willing to sell the particulars to the bidder. This sometimes creates issues for buying/selling non-volatile shares, but not in forex trades due to the large market.
For example, if the current bid price of a stock is $25.80, a trader may place a bid at $25.80, or anywhere below it. If the bid is placed at $25.00, then all other bids above that price level need to be filled before the price drops to $25.00 and possibly fills the $25.00 order.
If you place a buy order above the current bid price, you will either fall in-between the bid/ask spread or your order will hit the ask price. In that case, your buy order will be executed instantly since your buy order interacted with another sell order.
The bid-ask spread and the ask price are discussed later.
A trader who wants to exit a long (buy) position, or want to enter into a short position, can sell at the current bid price. A market sell order will instantly be filled at the bid price. Thus, Traders have a number of options when it comes to placing orders.
Traders can place a bid at or below the current bid (Limit Entry Order). They can also place an buy order above the current bid (Stop Entry Order), which will probably interact with another sell order or narrow the bid/ask spread, or even they can use a market order.
What is Ask Price in Trading?
The ask price represents the lowest valued sell order that is currently available, or the lowest price someone (including market makers) is willing to sell at (go short). The Ask price is also referred to as the offer price.
For example, if the current Ask price of a stock is $15.80, a trader may place an offer at $15.80, or anywhere above it (Limit Order). For an offer placed at $15.90, all other sell offers below that price must be executed before the price moves up to $15.90 and potentially fills the order.
A sell offer placed below the current ask price will either narrow the bid-ask spread or the order will hit the bid price. In that case the sell order will be filled instantly since the sell order interacted with another buy order.
A trader who wants to exit a short (sell) position, or want to enter into a long position, can buy at the current ask price. A market buy order will instantly be filled at the ask price. Thus, Traders gets a number of options when placing orders in Stock or forex market.
Traders can place an order at or above the current ask price (Limit Entry Order). They can also place an sell order below the current ask price (Stop Entry Order), which will probably interact with another buy order or narrow down the bid/ask spread, or even they can use a market order.
What is Bid-Ask Spread?
The bid-ask spread is the difference in price between the bid price and ask price of any particular stock, commodity, or currency.
The formula for calculating spread is :
Spread = Ask Price - Bid Price
The value of bid/ask spread depends on the liquidity of the asset. In active stocks, the bid/ask spread is as low as $0.01. In the forex market, the bid-ask spread is to be around 1 pip (or even in the pipette) for major pairs like EUR/USD and goes high as you trade in low volatile pairs.
[See Also: What is Pip and Pipette in Forex Trading]
Actually, the spread acts like the transaction cost. For example, even in highly active stocks or forex pairs, always buying on the offer means paying a slightly higher price (Ask Price) than what you get while Selling (Bid Price). Likewise at time of selling you get slightly lower price than what you must pay if you buy at the same time.
Particularly in forex, where there are no account fees, the spread is the sole income source of your broker.
The Relation Between the Bid/Ask Spread and Liquidity:
Though the bid-ask spread always fluctuates, the size of the bid/ask spread differs from one asset to another primarily because of their difference in liquidity.
Certain stocks or currency pairs are more liquid than others, For example, the bid-ask spread for a very liquid currency pair like EUR/USD or USD/GBP is charged around 1 pip, whereas for less volatile pairs like USD/MNX (Mexican peso) the bid/ask spread can go up to 3-5 pip.
Same for stocks, a highly volatile stock can have a spread of $0.01 whereas the spread of a low volatile stock can be as large as the 1-2% of their lowest ask price.
We hope that you have enjoyed the above article describing Bid-Ask Spread in Stock and Forex Trading. Be with us to explore forex trading, stocks trading, and other money-making opportunities.
Leave us some comments if you have any questions about Bid Price, Ask Price, and Bid/Ask Spread. Also, let us know how much spread is charged by your broker.