Bid-Ask Spread: Meaning, Formula & How It Works

Bid-Ask Spread: Meaning, Formula & How It Works

In online share trading, the bid-ask price is like a virtual meeting point for buyers and sellers. Bid price refers to the highest price at which buyers are willing to purchase a stock. While the ask price is, the lowest price sellers are willing to accept. A “bid-ask spread” is the difference between these two prices. Moreover, it's an essential factor to consider because it affects the cost of trading.

By understanding the bid and ask spread meaning, you can make smarter decisions when buying or selling stocks online. In this article, let's cover what a bid-ask spread means in detail, the bid-ask spread formula, how bid-ask spread works in online share trading, and key things you need to know about bid-ask price.

What is the bid-ask spread meaning?

Individuals, corporations, and governments use the stock market to buy and sell securities. For a complete understanding of buying and selling options, it's essential to understand what a bid-ask spread means. A bid-ask spread means that buyers and sellers set the stock price.

A "bid" is the price at which an asset is sold - stocks, funds, or other marketable securities. On the other hand, the "ask" is the price at which investors are willing to purchase the asset. 'Spread' is what's different between these two values. Generally, the lower the difference between the two prices, the more liquid the asset. Also, investors prefer liquid assets because they take a smaller financial hit when bought and sold.

Start Your Stock Market
Journey Now!

50 Years Trust |₹0 AMC |₹0 Brokerage *

Table of Content

  1. What is the bid-ask spread meaning?
  2. Bid-ask spread formula
  3. How Does bid-ask spread work?
  4. What is narrow vs. wide bid-ask spread?
  5. Things you should know about the bid-ask price
  6. Conclusion

Bid-ask spread formula

After understanding bid-ask spread meaning, let us know how to calculate the price. You can calculate the bid-ask price as a percentage or absolute value. Often, spread values on highly liquid markets are quite small. Conversely, when markets are less liquid or illiquid, spreads can be very significant.
 

Following is the bid-ask spread formula:

(Absolute) bid-ask spread formula 

Ask Price - Bid Price


 


 

(Percentage)  bid-ask spread formula

Ask Price - Bid Price


 

 


 

Ask Price


 

X 100

Assume a stock is trading at Rs. 9.50 or Rs. 10. The bid price is Rs. 9.50, while the (ask) offer price is Rs. 10. Considering the bid-ask price in absolute terms, it is 0.50 paise. On a percentage basis, the spread will be 0.50 paise or 0. 50 percent.

If as a buyer, you purchase stock at Rs. 10 and immediately sell it at Rs. 9.50 - either purposefully or accidentally - you will lose 0.50 percent of the transaction value due to this spread. If you bought 100 units of the stock and immediately sold them, you would lose Rs. 50. In contrast, if 10,000 units are bought and sold, the loss would be Rs. 5,000. 

How Does bid-ask spread work?

Stock exchanges and broking houses help people buy and sell stocks. They have a cost for their services, which can affect the stock price, similar to how delivery fees are added when you shop online.

When you want to buy or sell a stock, there are rules to decide which trades happen first. You can place a market order if you want your trade done quickly. This also means you accept the price the market offers at that moment.

If you can access online pricing systems, you can see the bid and ask for stock prices. Moreover, these prices are never the same. Price asks are generally higher than bids. The broker who manages the transaction keeps this difference as their profit. However, broking firms' commission fees are often higher than retail brokers.

The bid-ask price covers various costs and the broker's commission. Some big companies, called market makers, can decide the bid-ask price by offering to buy and sell a particular stock. They use the spread to cover their costs and make a profit.

What is narrow vs. wide bid-ask spread?

The bid-ask spread is the difference between the asking price and the bidding price of a security or asset in the financial market. It's the difference between what a buyer will offer (the bid price) and what a seller will accept (the ask price). The spread is determined mainly by supply and demand. If the bid and ask prices are close, there's plenty of liquidity. It's called a "narrow" bid-ask price. 

If there is liquidity, it is much easier to buy or sell a security at a competitive price. Conversely, when the spread between the bid and ask is wide, trading is difficult and expensive.

Things you should know about the bid-ask price

Here are five things you need to know about bid-ask prices:

1. Bids are the highest prices buyers are willing to pay when buying securities.

2. When selling securities, the asking price is the lowest price a seller is willing to accept.

3. In trading terms, the asking price is often called the “offer price.”

4. If the bid price and the asking price overlap, the trade is executed.

5. Stocks and liquid funds tend to have a narrower bid-ask price. In contrast, if a stock or fund's liquidity is low, its bid-ask price widens.

Conclusion

Bid-ask spreads are the difference between how much buyers are willing to pay (bid) and how much sellers are willing to accept (ask) for a stock. Understanding the bid-ask spread meaning helps you make informed decisions while trading. You can also download the blinkX stock trading app for assistance in making informed decisions. With their paperless activation and user-friendly app, they assist in portfolio building. 

Additionally, it's important to consider the spread, as it affects the cost of trading and reflects the market's liquidity.  The bid-ask price can be calculated as a percentage or absolute number. On highly liquid markets, spreads are usually pretty small. On the other hand, spreads can be really big when markets are less liquid or even illiquid.

Bid-ask spread FAQs

Negative bid-ask spreads mean market makers are inverting markets, meaning they're ready to buy securities at higher prices than they'd sell them for.

Market makers can profit from a bid-ask by buying and selling assets simultaneously. They make money by selling at the higher ask price and buying at the lower bid price.

The seller won't sell at a lower rate, so the asking price will always be higher.

An Ask price is the lowest price at which someone is willing to sell the stock, and a bid price is the highest price at which someone is willing to buy it. When Bid = Ask, a trade is executed. When you place a market order, you agree to buy at the Ask or sell at the Bid.

A wider bid-ask spread means less liquid and more volatile stocks. A big spread means traders don't trade as often, and when they do, prices jump around more quickly than a stock that moves a few pennies at a time.