What is a Bid-Ask Spread?

//What is a Bid-Ask Spread?
What is a Bid-Ask Spread? 2017-10-01T02:19:41+00:00

Definition: The bid-ask spread refers to the difference between the bid price and the asking price for a certain investment. In other words, it represents the difference between the maximum amount a buyer is willing to pay for an instrument and the minimum price the seller is willing to take for the instrument.

What Does Bid-Ask Spread Mean?

What is the definition of bid-ask spread? The bid ask spread is a concept that is widely used in trading, specifically relating to equities. Thus, trading professionals, financial professionals, and others frequently refer to the bid ask spread of a certain investment. The bid price, or price a buyer is willing to pay, and the sell price, or the price a seller is willing to sell, are vital to determining the market for an investment. It is also important to institutional investors, such as hedge fund managers, who need to know the spread, especially for less liquid investments where the spread can be greater.

Let’s look at an example.

Example

Maria is a professional trader at a large brokerage firm, performing work for institutional clients such as hedge funds and proprietary trading organizations. As part of her job, she places trades for these clients, and is routinely asked about the spread for certain investments. As she knows from experience, the bid ask spread depends widely on the liquidity, or availability, of the investment: a very liquid investment will have a low bid ask spread, whereas a very illiquid investment will have a large spread.

Currently, Maria is placing an order for Company, which is currently priced at $450 per share. Her client wants to know the bid-ask spread, so she looks at her data: the highest purchase price for a Company share is $455, where the lowest sell price for a Company share is $460. In other words, the spread is $5, expressed as the spread divided by the lowest asking price, is (5/460) = 1.09%. This is a very low spread, which means a high liquidity for investors and an easier ability to buy and sell the stock.

Summary Definition

Define Bid Ask Spreads: Bid-Ask spread means the amount that the bid price of an asset exceeds the ask price of that investment in the marketplace.