A:

The variance between a security's bid price and its ask price, also known as the bid-ask spread, represents the different valuations between buyers and sellers in the market. In the stock market, actors communicate through offered prices; bids are what buyers are willing to pay and asks are what sellers are willing to accept.

How Stock Orders Are Filled

To understand the bid-ask spread, it's critical to first understand how stock orders are filled. When a potential buyer enters the market, he focuses on the ask prices (he wants to trade with a seller and make a deal).

If the quoted ask price of a stock is $50.35, that means the lowest offer by any seller in that particular market is $50.35. If the buyer is willing to pay the ask, he can then place a limit order on the seller's shares. Unless his order is jumped by another buyer, the order is filled and the trade takes place.

Sellers, on the other side, focus on the bid side. The bid for the same stock might only be $50.25, representing the highest present quoted offer in the market by buyers.

The Bid-Ask Spread

The spread is the difference between the bid and ask price. In the above example, the spread is 10 cents ($50.35 - $50.25). A tight spread reflects a lot of liquidity and competition in the stock; many actors are involved in the marketplace. Narrow spreads are more attractive.

Bid prices are always lower than ask prices. Buyers are always paying more than sellers are receiving. In many respects, the bid-ask spread is what the broker is paid; it's the cost of matching up buyers and sellers. This is why highly liquid markets, where it is relatively easy to find offers, have the lowest spreads.

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