The bid-ask spread in investing is the difference between the bid price and the ask price of any particular financial security such as stocks, bonds, commodities futures and even foreign exchange currencies. The bid-ask spread is variable, and is a form of compensation to market makers paid by traders and investors in exchange facilitating the trades. Stocks with a narrower bid-ask spread benefit investors because it helps to maintain low trading costs. A wider bid-ask spread could also indicate that a stock has liquidity issues and an investor can not buy and sell shares as easily as a stock that has more trading activity. A narrow bid-ask spread, on the other hand, is a positive sign.
Bid Price Explained
The bid price of a financial instrument is the highest price an investor is willing to pay to purchase shares of the security. The bid price is usually higher than the current market price, but there are instances where the bid price and the market price will be the same. Depending on the liquidity and trading volume of the stock, top bid prices can fluctuate.
Ask Price Defined
The ask price is the minimum price a seller of stock is willing to accept for their shares. Like the bid, throughout the day the ask price will fluctuate second by second depending on the trading action, a short term investor needs to pay close attention to these prices if they are working with a short term investment strategy.
Stocks that are widely traded, or more liquid, will usually have a lower bid-ask spread. A bigger spread between the bid and ask prices means that a stock is less liquid and buyers and sellers may find it more difficult to find a counterparty for their trades unless they are willing to adjust their orders. For investors using market orders instead of limit orders, a trade could end up costing more because in order to fill the bid size, the investor will have to raise their bid price.