Gain a comprehensive understanding of the bid-ask spread in the stock market, how it benefits market makers, and factors that influence its size and liquidity.
- 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 bid-ask spread works to the advantage of the market maker
- The smaller the spread, the greater the liquidity of the given security
- Bid-ask spreads can vary widely, depending on the security and the market. Blue-chip companies that constitute the Dow Jones may have a bid-ask spread of only a few cents, while a small-cap stock that trades less than 10,000 shares a day may have a bid-ask spread of 50 cents or more
- Bid and ask prices are set by the market. In particular, they are set by the actual buying and selling decisions of the people and institutions who invest in that security. If demand outstrips supply, then the bid and ask prices will gradually shift upwards
Example:
Remember, the bank will always: Buy Low / Sell High
The Bid Price (what the bank will pay to buy yours): $24.66
The Ask Price (what you will have to pay the bank to buy): $24.71
If the bank buys 1,000,000 shares at $24.66
And sells 1,000,000 shares at $24.71
Makes a profit of $50,000