What is supply and demand?
The term bid and ask (also known as offer and offer) refers to a bidirectional quote which indicates the best potential price at which a security can be sold and bought at a given time. The price offered represents the maximum price that a buyer is willing to pay for a share of stock or other security. The asking price represents the minimum price that a seller is ready to take for this same title. An exchange or transaction takes place after the buyer and the seller have agreed on a price for the security which is neither higher than supply nor lower than demand.
The difference between the bid and ask prices, or the spread, is a key indicator of asset liquidity. In general, the smaller the spread, the better the liquidity.
Bid and ask
Understanding supply and demand
The average investor challenges the offer and demands the spread as an implied trading cost. For example, if the current price of security A is $ 10.50 / $ 10.55, investor X, who is looking to buy A at the current market price, would pay $ 10.55, while investor Y who wishes to sell A at the current market price would receive $ 10.50.
Key points to remember
- The offer price refers to the higher price that a buyer will pay for a guarantee.
- The asking price refers to the lowest price that a seller will accept for a guarantee.
- The difference between these two prices is known as the spread; the smaller the difference, the greater the liquidity of the given security.
Who benefits from the bid-ask spread?
The bid-ask spread works to the advantage of the market maker. To continue with the above example, a market maker quoting a price of $ 10.50 / $ 10.55 for title A indicates his willingness to buy A at $ 10.50 (the price of the offer) and sell it at $ 10.55 (the asking price). The difference represents the profit of the market maker.
Bid-ask spreads can vary widely, depending on security and the market. The blue chip companies that make up the Dow Jones Industrial Average can have a bid-ask spread of just a few cents, while a small-cap stock can have a buy-sell spread of 50 cents or more.
The bid-ask spread can widen considerably during periods of illiquidity or market turbulence, as traders will not be willing to pay a price above a certain threshold and sellers may not be willing to accept prices below a certain level.