What is Price Tension

Price tension occurs when there is a large difference between the price a seller is asking and the price a buyer is willing to pay, which results in a wider bid-ask spread.

BREAKING DOWN Price Tension

Price tension determines the spread between bid and ask prices in securities markets. When sellers ask for more than what the majority of buyers are willing to pay, it reduces the number of exchanges made within the market. This reduced breadth or volume of orders reduces liquidity — which is why bid-ask spreads are used as a proxy for liquidity (though they are also affected by market volatility).

The most liquid financial instruments, such as currencies, have the smallest bid-ask spreads, while thinly traded illiquid assets, such as penny stocks can have huge bid ask spreads. Markets with narrow bid-ask spreads are known as tight markets.

The bid-ask spread can say a lot about a security — and the market clearing price — which is why traders pay close attention to it. Limit orders are more likely to be used when securities are thinly traded, and bid-ask spreads are wider because otherwise, the trading charges can eat into profits.

For further reading, see Why The Bid-Ask Spread Is So Important.