The term bid and ask refers to the best potential price that buyers and sellers in the marketplace are willing to transact at. In other words, bid and ask refers to the best price at which a security can be sold and/or bought at the current time.
The Bid Price
The bid price is the price that an investor is willing to pay for the security.
For example, if an investor wanted to sell a stock, he or she would need to determine how much someone is willing to pay for it. This can be done by looking at the bid price. It represents the highest price that someone is willing to pay for the stock.
The Ask Price
The ask price is the price that an investor is willing to sell the security for.
For example, if an investor wants to buy a stock, they need to determine how much someone is willing to sell it for. They look at the ask price, the lowest price someone is willing to sell the stock for.
Understanding Bid and Ask
Bid and ask is a very important concept that many retail investors overlook when transacting. It is important to note that the current stock price is the price of the last trade – a historical price. On the other hand, the bid and ask are the prices that buyers and sellers are willing to trade at. In essence, bid represents the demand while ask represents the supply of the security.
For example, if the current stock quotation includes a bid of $13 and an ask of $13.20, an investor looking to purchase the stock would pay $13.20. An investor looking to sell the stock would sell it at $13.
Example of Bid and Ask
John is a retail investor looking to purchase stocks of Security A. He notices the current stock price of Security A is at $173 and decides to purchase 10 shares for $1,730. To his confusion, he noticed that the total cost came out to $1,731.
John assumed that it must’ve been an error. He later realizes that the current stock price of $173 is the price of the last traded stock of Security A and that he paid the asking price of $173.10.
Considering the Bid-Ask Spread
The difference between the bid and ask prices is referred to as the bid-ask spread. The bid-ask spread benefits the market maker and represents the market maker’s profit. It is an important factor to take into consideration when trading securities, as it is essentially a hidden cost that is incurred during trading.
For example, if a security received a bid of $10 and an ask of $11, an investor would expect to lose $1 or 9% of their investment if they bought at the asking price of $11 and then immediately changed their mind and sold at the bid price of $10.
When the security is highly traded (liquid), the spread will be low. On the other hand, when the security is seldom traded (illiquid), the spread will be larger. For example, the bid-ask spread of Facebook Inc., a highly traded stock with a 50-day average daily volume of 25 million, is one (1) cent.
Comprehensive Trading & Investing eBook
From capital markets to trading and technical analysis strategies, CFI's 115-page Trading & Investing eBook covers all the major topics a world-class analyst needs to know!
To keep advancing your career, the additional resources below will be useful: