The bid price and the ask price are fundamentals when learning to trade stocks or cryptocurrencies. If you don’t understand them, you might end up on the wrong side of a trade and have lost all your profits.
What is the difference between bid price and ask price?
When investing, the bid price means the maximum someone is willing to pay. The ask price is the minimum someone is willing to sell for.
Let’s break this down. Let’s say you wanted to buy 10 shares of a company you are ready to invest in, and want to spend $100 total. You would set your bid price (which is the maximum you are willing to pay for each share of stock) at $10. That means that someone that is looking to sell their shares of that stock will need to set their ask price (the minimum they are willing to sell each share of stock) at $10 for each share of stock. If that happens, boom, a transaction is made and money and stock change hands.
The bid-ask spread is really only the difference between the ask price and the bid price. You’ll normally see the bid-ask spread displayed like this:
Which would be a spread of $1. That means that buyers are willing to buy at the price of $10, and sellers are willing to sell at the price of $11.
Another important term is crossing the spread. That means if someone is willing to purchase at the ask price, even if there is a bid-ask spread, they are crossing the spread.
It doesn’t matter if you are a buyer or a seller the bid price and the ask price are what is setting the market value.
Let’s use our example from above. You now own 10 shares of stock in a company you are excited about and want to sell them at market value. The market value in this case would be the bid price from the bid-ask spread. If the bid price was $11, that means you would sell your shares for a grand total of $110.
On the other hand, if you wanted to buy 10 more shares in the company you are excited about and are going to make a market order. That means that you will be paying the ask price from the bid-ask spread. If the ask price is $12, that means your market order will cost you $120.
In the end, the market price is really just how much the other side of the trade is ready to transact at.
If a stock has a large delta between the ask price and the bid price, that usually means there is not a lot of trading that is happening. If you are a seller, that’s not great news because you could be left holding a stock that you don’t want to own anymore.
On the other side of the coin, if the spread of the bid price and the ask price of a stock is small it is much easier to sell. As a seller that is great news because that means there is a ton of trade value close to the ask price. Which means less risk for you as an investor.
A good example is a snow cone salesman. If you are selling snow cones in the Himalayas, the demand is low. Let’s say your snow cones are delicious, and you have set the price to be $5. Your customer base in the Himalayas are most likely not going to be interested in a snow cone and are really only willing to pay $1. That would be a bid-ask spread of $4. Now, you are left with a less than optimal option, choose to sell your snow cones for much less and cut your losses. On the other hand, you could choose to stay at your price of $5, but you might need to move to Hawaii for someone to buy a snow cone at your ask price. That’s low liquidity.
If you lowered your price all the way down to $1.01, the bid-ask spread would only be a penny. The difference between the bid price and the ask price would be very small, and you would then be able to increase sales. That would mean you would be much more liquid.
That’s the same with stocks, cryptocurrencies, etc. The closer the bid and ask price are to each other, the more liquidity there is.
A limit order is a way to sell or buy a stock at a set price instead of at the market price. If you are going to sell a share of stock at $10 and set a limit sell order at $10 your stock will not be sold until someone is willing to buy your stock from you at $10.
If you are a buyer it works the same way. If you want to buy a stock at $10, and it is currently at $11 you can set a limit buy order and your purchase order won’t go through until the stock reaches $10.
The downside of a limit order is that your order may never execute if your condition is never met.
There are a few factors that can affect the bid-ask spread. We are going to cover three of them: Market Size, Volatility, and Political/Economic Uncertainty.
The bigger the size of a market and the more trading volume there is on a daily basis, the higher chance there will be that the bid-ask spread is smaller. If there are 10 million people that want to buy Bitcoin right now, you better believe it will be easy to liquidate your holdings.
However, if you bought into some unknown stock that has very little liquidity, it could be very difficult to sell your stock when you want to.
Volatility makes a larger bid-ask spread. If the price of a stock goes up and down like a rollercoaster market-makers won’t be able to successfully set an ask price or a bid price. When something is unpredictable, it lowers the amount of liquidity, and the missing liquidity is seen in the size of the bid-ask spread.
When there is political or economic uncertainty, investors are usually much more reserved and are not as active. That means buyers aren’t buying as much, and sellers are not selling as much. That also results in a lack of liquidity which in turn creates a larger bid-ask spread. Just like volatility.
Bid price and ask price are paramount to understand as an investor. You also need to understand the bid-ask spread, and what key factors can affect it.
Investing can be complex, to say the least, but when you boil it down it is really just knowing all about bid price and ask price.