What is Bid and Ask?
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. It can be done by looking at the bid price – the highest 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 wanted to buy a stock, he or she would need to determine how much someone is willing to sell it for. It can be done by looking at the ask price – the highest that 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 securities at. In essence, bid represents the demand while spread 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 while 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 log onto his brokerage account and purchase 10 shares (total cost = $1,730). To his confusion, when he executed the buy order, he noticed that the total cost came out to $1,731.
John assumed that it must’ve been an error, as the stock price of Security A is $173. He later realizes that the current stock price of $173 is the price of the last traded stock of Security A and that he would’ve to pay the asking price of $173.10 per stock of Security A.
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), they 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.
In the example above with a bid / ask of $172.80 / $173.10, the bid-ask spread would be 30 cents – the market maker’s profit.
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