What is the Bid vs. Ask Price?
Of the many fundamental chart metrics new investors need to get familiar with, bid-ask spread is near the top of the list. Thankfully, it’s also one of the easiest to understand. What is the bid vs. ask price? What does it mean for a security? To understand it fully, you need to have a basic grasp on economics—specifically, supply and demand. Getting familiar with bid-ask will help you make more informed decisions about when to enter and exit positions—especially if you’re a day or swing trader.
Breaking Down Bid vs. Ask
Look up any stock chart or currency pair chart and you’ll see bid-ask displayed somewhere. This is a range—for example, $10.25-$10.35. The former number is the bid figure; the latter is the ask figure.
- Bid price is the maximum price a buyer is willing to pay for a security.
- Ask price is the minimum price a seller is willing to part with the security for.
The bid-ask range (also called a spread) governs transactions surrounding the security. Before entering or exiting a position in that security, investors should reference the bid-ask to understand what they can buy or sell it for. This is particularly important for traders, who seek to capitalize on incremental movements in price.
Understanding the Bid-Ask Range
The bid-ask spread is more than a two-way quote—it’s a representation of liquidity, as well as supply and demand. As a general rule of thumb, smaller spreads represent stability, while larger spreads represent riskier investments. The larger the spread, the larger the gap between willing buy and sell prices.
A small bid-ask range is usually tenths of a percent of the share price. For example, Johnson & Johnson (NYSE: JNJ) might have a bid-ask of $170.00-$170.18. This is a blue chip stock with plenty of liquidity and demand, which makes it easier for buyers and sellers to come to an agreement and transact the stock.
Larger bid-ask ranges can vary greatly. Take a company like Community Health Systems (NYSE: CYH), with a bid-ask of $13.52-$14.19. If the share price is $13.62, this spread is almost five percent! It’s an indicator that buyers and sellers are far apart in their valuation of the stock. As a result of this discrepancy, there’s likely less volume, since it takes more effort to reach a transaction point.
Bid-ask spread is ultimately a health indicator of a security. Small spread equals more volume and liquidity; higher spread signals, less volume and less liquidity.
Who Sets Bid-Ask Prices?
The market is responsible for setting bid-ask prices and determining the spread. Again, this is a function of supply and demand. If there’s a larger contingent of sellers, the bid-ask range will drift lower—sellers need to be more competitive in selling price to attract buyers. Conversely, if there are more buyers, bid-ask favors sellers and climbs.
The actual range between the bid and ask prices is a function of volume. High volume narrows the spread, since there’s more activity to close the gap. Less volume equates to less activity, which broadens the gap between buyers and sellers. It’s the free market at work!
Capitalizing on the Bid-Ask Spread
There are several ways to capitalize on a security’s bid-ask spread in a productive way. The first and easiest step is to be aware of exactly what that spread is at the time of your transaction. These spreads constantly change based on the movement of the market, so it pays to have real-time information about bid-ask if your trades capitalize on that range.
The next best way to work with the bid-ask spread is through limit orders. While market orders fill based on available shares, limit orders fill based on bid-ask prices. If you’re trading to take profit or capitalize on a dip, a limit order will help avoid slippage as the result of a moving bid-ask range.
With insight into what the bid-ask spread is and a working knowledge of limit orders, traders can capitalize on several other strategies to make sure they’re staying on the right side of the ratio:
- Look at the spread percentage, not just spread. Spread percentage provides context within price. For example, Stocks A and B might both have a bid-ask range of $0.10; however, if the range is $50.10-$50.20 for Stock A and $5.10-$5.20 for Stock B, there’s a major difference in spread percentage.
- If you’re trading forex or commodities, shop around for different spreads. Different brokerages or marketplaces may offer different spreads, varying by a few pennies or a few pips. This is technically a form of arbitrage. While rare, it does happen in a space for retail investors to capitalize.
- Depending on their position, investors can capitalize on volatility in favor of a position entrance of exit. For example, if there’s high volatility and a narrow bid-ask in favor of sellers, you might take profits. Likewise, low volatility and a larger spread in favor of buyers may allow you to add to a position.
Track bid-ask as part of your general approach to investing and it’ll quickly become an important tool in how you evaluate the decision to buy or sell at a specific time.
Every Investor Needs to Understand Bid-Ask
No matter your experience level, it’s important understand the difference between a bid and ask price. In addition, it’s always a great idea to stay ahead of the most recent investment knowledge and trends. Therefore, sign up for the Investment U e-letter below to expand your investing insights.
So, what is the bid vs. ask price of a stock? More than just a measure of buying and selling prices, it’s a representation of supply and demand, and liquidity. Familiarize yourself with how the bid-ask range works, how it fluctuates and the role it plays when it comes to entering or exiting positions. And, if you’re a trader, be aware of how it impacts your ROI! It’s a simple metric, but a vital one.