What is the BID ASK Spread? – Explanation

Definition and explanation:

The BID is the current buy price (bid price) at which a buyer is willing to buy (via limit order) and the ASK is the current sell price (ask price) of a value at which the seller is willing to sell (via limit order), traded on the exchange. Traders are willing to buy (BID) and sell (ASK) at a certain price at a certain limit. The spread may vary depending on the broker and the current market!

  • spread: The distance between BID and ASK
  • BID: Highest price at which a buyer wants to buy (bid price)
  • ASK: Lowest price at which a seller wants to sell (ask price)

Understanding the Bid and ASK in the Order Book

The order book is the inner workings of the stock exchange. There you can experience the price formation live. Every exchange-traded market has its own order book. Liquidity can always vary. This refers to how many contracts or values are to be sold or bought. The BID or ASK always contains a certain number of orders (colloquially). The idea behind this is that a trader wants to buy or sell automatically at a certain price.

Difference between Limit and Market Orders

It is very important to understand the difference between limit and market orders. Once you understand this concept, you will know how the exchange or pricing of a market works.

The price is only moved by using the market order. Without the direct buy or sell order, the price would not move because nobody would serve the limits on the BID or ASK. The orders on the BID or ASK are then processed by Market Order. If there are no more orders on the BID or ASK, the price must change.

Example:

On the price (picture above) 2772,25 there are 6 limit orders (ASK). There must be 6 buy market orders executed for the price to go up 1 tick. In this order book there is no additional BID ASK spread (futures). There is always only 1 tick spread so to speak.

Important summary:

  • Limit orders are placed on the BID and ASK and need to be filled
  • This service is only provided through direct market orders (buy or sell)
  • If you buy directly, another trader sells his position directly on the BID
  • If you sell directly, another trader buys your position directly on the ASK

If there are no more orders on the BID or ASK, there must be a price change.

How does the BID and ASK spread come about now?

Please note that not every market or financial product has an additional BID and ASK spread. For example, liquid futures contracts have no BID and ASK spread or 1 tick. Non-liquid shares can have a high BID and ASK spread. The current market situation also plays a role in the BID and ASK spread.

Facts that influence the BID and ASK spread:

  • Market
  • Market situation
  • How much orders are available?
  • Broker
  • Market Makers

Financial product

In addition, it is possible that the broker may hedge by means of a spread in volatile market situations. If the market moves too quickly, this can lead to a slippage and you will not be executed at the desired price. To avoid this, a spread is added. In addition, the broker himself has to get the price executed on the market. In the further course of this page I recommend you to use providers with a very low spread and fees.

Brokers and the BID ASK spread:

  • There are brokers who make money by adding a spread
  • There are brokers who do not charge an additional spread but do charge a trading commission
  • The broker can protect himself against high volatility and slippage with a spread

Where can I get a high BID and ASK spread?

In the following table I would like to show you where you can expect a high or low BID and ASK spread:

  • Liquidity
  • Market situation (volatility and volume)
  • Brokers

Forex and CFD brokers earn money by offering an additional spread

Forex and CFD brokers can intervene in the BID and ASK spread. Many providers add an additional spread to the normal market to make money. A commission or fee per order is then eliminated. However, most of the time a broker offers both models in different accounts. There is often an account with additional spread without trading commission and an account with direct spread and trading commission.

LOW SPREAD:HIGH SPREAD:
Futures (futures contracts)Low liquidity stocks
Highly traded stocks (high liquidity)Markets with high volatility / movement and little trading volume
Forex (currencies) – very liquid market, but the spread depends on the broker

Save costs with a low cost broker:

As mentioned above, brokers also influence the spread because they earn trading fees. An additional spread is added to the trader’s disadvantage. This compensates for the missing commission. This business model is unproblematic, however, when choosing a broker you should make sure that the provider offers the trader favorable conditions.

In more than 7 years of experience in the financial markets I have tested and compared many brokers.

In the table below I present you the overall winners with favourable spread and trading fees:

Conclusion: The BID and ASK Spread is necessary

The spread is necessary for smooth price formation and stock exchange trading. There is not always sufficient liquidity (supply and demand) at a given price. Therefore the spread can increase. BID is the price at which traders are willing to buy and ASK is the price at which traders are willing to sell. The orders are processed by direct market orders (buy and sell).

Stock exchange trading is not witchcraft. For beginners it is especially important to understand the terms used in trading to avoid fatal mistakes.

Good luck with trading!

Summary:

  • Limit orders wait to be triggered by market orders
  • ASK is a selling limit
  • BID is a buying limit
  • Market orders trigger the limit orders on the ASK or BID
  • The spread can be determined by the broker, market situation or the financial product

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