That's because mutual funds only set their prices once a day and investors pay the same price to buy or sell a fund. Understanding the bid-ask spread when trading stocks is critical in getting the best price, either as a buyer or a seller. That's especially the case with stocks that aren't traded that often i.
It's understandable that investors may scratch their heads over the math behind the bid-ask spread. After all, in a bid-ask scenario, the buyer is being asked to pay the higher price the ask and the seller is being asked to accept the lower price the bid. The reality is that most investors won't see much of an impact on bid-ask spreads, especially if they're trading higher-profile, highly-liquid stocks where the bid-ask spreads are tighter and where buyers and sellers aren't as impacted by bid-ask spreads.
Highly liquid stocks. Low liquidity stocks. Or, consider a stock that doesn't trade that often - we'll call it XYZ Corp. Usually, while investors can find low-liquidity stocks in all corners of the financial markets, you'll find them mostly in the small-capitalization small cap sector, or lightly-traded exchange-traded funds ETFs , where stocks don't trade as often as large, more liquid stocks like 3M.
The bid-ask spread is how a broker or market makes a profit on a trade execution - the price the stock specialist charges for efficiently and quickly matching up buyers and sellers.
When stocks and funds don't trade as often, the market specialist works harder to match up buyers and sellers, usually with a security that trades with higher volatility.
For that extra effort, the broker or market maker charges a markup to investors, for the extra work - and the extra price risk - they're taking on. Once fully explained, the concept of bid and ask becomes easier for investors to understand, and to apply the spread into their trading decisions.
The bid-ask spread can also be stated in percentage terms; it is customarily calculated as a percentage of the lowest sell price or ask price. This spread would close if a potential buyer offered to purchase the stock at a higher price or if a potential seller offered to sell the stock at a lower price.
Some of the key elements to the bid-ask spread include a highly liquid market for any security in order to ensure an ideal exit point to book a profit. Secondly, there should be some friction in the supply and demand for that security in order to create a spread. Traders should use a limit order rather than a market order; this means that the trader should decide the entry point so that they don't miss the spread opportunity.
There is a cost involved with the bid-ask spread, as two trades are being conducted simultaneously. Finally, bid-ask spread trades can be done in most kinds of securities—the most popular being foreign exchange and commodities. In financial markets, a bid-ask spread is the difference between the asking price and the offering price of a security.
The bid-ask spread is the difference between the highest price the seller will offer the bid price and the lowest price the buyer will pay the ask price. Typically, a security with a narrow bid-ask spread will have high demand.
By contrast, a security with a wide bid-ask spread may illustrate a low volume of demand, therefore influencing wider discrepancies in its price.
Bid-ask spread, also known as spread, can be high due to a number of factors. First, liquidity plays a primary role. When there is a significant amount of liquidity in a given market for a security, the spread will be tighter.
Stocks that are traded heavily, such as Google, Apple, and Microsoft will have a smaller bid-ask spread. Conversely, a bid-ask spread may be high to unknown, or unpopular securities on a given day. These could include small-cap stocks, which may have lower trading volumes, and a lower level of demand among investors. While this spread may seem small or insignificant, on large trades, it can create a meaningful difference, which is why narrow spreads are typically more ideal.
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Develop and improve products. List of Partners vendors. Table of Contents Expand. Table of Contents. Bid-Ask Pricing. Market Orders. The Bottom Line. By Ken Little Full Bio LinkedIn Twitter Ken Little has more than two decades of experience writing about personal finance, investing, the stock market, and general business topics. He has written and published 15 books specifically about investing and the stock market, many of which are part of the well-known franchise, The Complete Idiot's Guides.
As a freelance writer and consultant, Ken focuses on stocks , trading basics, investment strategy, and health care. Learn about our editorial policies. Reviewed by Brandon Renfro.
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