What Is Bid and Ask?
The term bid and ask (also known as bid and offer) refers to a two-way price quotation that indicates the best potential price at which a security can be sold and bought at a given point in time. The bid price represents the maximum price that a buyer is willing to pay for a share of stock or other security. The ask price represents the minimum price that a seller is willing to take for that same security. A trade or transaction occurs after the buyer and seller agree on a price for the security which is no higher than the bid and no lower than the ask.
The difference between bid and ask prices, or the spread, is a key indicator of the liquidity of the asset. In general, the smaller the spread, the better the liquidity.
Bid And Asked
Understanding Bid and Ask
The average investor contends with the bid and ask spread as an implied cost of trading. For example, if the current price quotation for security A is $10.50 / $10.55, investor X, who is looking to buy A at the current market price, would pay $10.55, while investor Y who wishes to sell A at the current market price would receive $10.50.
- The bid price refers to the highest price a buyer will pay for a security.
- The ask price refers to the lowest price a seller will accept for a security.
- The difference between these two prices is known as the spread; the smaller the spread, the greater the liquidity of the given security.
Who Benefits from the Bid-Ask Spread?
The bid-ask spread works to the advantage of the market maker. Continuing with the above example, a market maker who is quoting a price of $10.50 / $10.55 for security A is indicating a willingness to buy A at $10.50 (the bid price) and sell it at $10.55 (the asked price). The spread represents the market maker's profit.
Bid-ask spreads can vary widely, depending on the security and the market. Blue-chip companies that constitute the Dow Jones Industrial Average may have a bid-ask spread of only a few cents, while a small-cap stock may have a bid-ask spread of 50 cents or more.
The bid-ask spread can widen dramatically during periods of illiquidity or market turmoil, since traders will not be willing to pay a price beyond a certain threshold, and sellers may not be willing to accept prices below a certain level.