If you’ve been wondering about the difference between the Bid and Ask price, then you’ve come to the right place. We’ll try to elaborate and go through the essential definition of both these trading concepts.
What is a Bid Price?
A bid price is a price that is offered for a commodity, contract, or service. Usually, a bid is much lower than an asking price, also known as “ask,” and the main difference between these two is called a bid-ask spread.
Generally speaking, a bid price is the amount of money a buyer is willing to pay for security. Bid prices are often designed to extract a desirable outcome for the trader who is making the bid.
For example, imagine the asking price for a good you want to buy is forty dollars. However, you want to pay thirty dollars for product, and you might make a bid of twenty dollars. Thus, the buyer and the seller have a chance to appear to compromise and give up something by agreeing to meet in the middle-exactly where they wanted to be in the first place.
Fun fact, if multiple buyers put in bids, it can develop into a bidding war. Eventually, two or more buyers end up placing incrementally higher bids. The battle will end when a price is settled upon when a buyer makes an offer which their rivals are unwilling to top. A bid price generally arrives through a process of negotiation between the seller and single or multiple buyers.
Bid and Ask Price
Now let’s move on to the ask price. Well, the ask prices usually represent the opposite of the bid price. The minimum price that a seller is willing to take for that same security. The transaction, or trade, frequently occurs after the buyer and seller agree on a price for the security, which is no higher than the bid and no lower than they ask.
The difference between the bid and ask prices, or the spread, is a crucial indicator of the liquidity of the asset. In general, the smaller the spread, the better the cash.
Benefits from the Bid-Ask Spread
Also, remember that the bid-ask spread mostly works to the advantage of the market maker. For example, a market maker is quoting a price of USD 10,50 / USD 10.55 for security A is indicating a willingness to buy A at USD 10.50 (the bid price) and sell it at USD 10.55 (the asked price). The spread represents the market maker’s profit.
Bid-ask spreads can vary; it all depends on the security and the market. Usually, Blue-chip companies that constitute the Dow Jones have a bid-ask of few cents. Meanwhile a small-cap stock that trades less than 10 000 shares a day may have a bid-ask spread of 50 cents or more. It’s all relative.
The bid-ask spread can widen hugely during periods of market turmoil or illiquidity. This is the result of traders that are not willing to pay the price beyond a certain threshold, and sellers may not be willing to accept costs below a certain level.
What did you learn?
In conclusion, we can say that the bid price refers to the highest price a buyer is willing to spend on security. Meanwhile, the ask price refers to the lowest price; a seller will accept for a security.
The difference between two prices is known as the spread; the smaller the spread, the higher the liquidity of the given security. That’s it, that’s all you need to know about the difference between the bid and ask price.