What are the bid and the ask?
– Bid: the highest price someone is currently willing to pay for a security (the buy side).
– Ask (also called the offer): the lowest price someone is currently willing to accept to sell that security.
– Bid–ask spread: the difference between the ask and the bid. It is an implicit trading cost for someone who takes the market price.
How the two-sided quote works
– Market quotes normally show two numbers: bid / ask. For example, 10.50 / 10.55 means the best buy order is for $10.50 and the best sell order is for $10.55.
– If you place a market order to buy, you typically pay the ask; if you place a market order to sell, you typically receive the bid. Traders who trade immediately at those quotes are called market takers.
– Market makers (firms or designated participants that post continuous bids and asks) profit by buying at the bid and selling at the ask. They help supply liquidity — the ability to transact quickly without moving the price.
Why the spread matters
– The spread is an indirect cost: immediately buying then selling at the displayed prices results in a loss roughly equal to the spread (ignoring fees and commissions).
– Narrow spreads indicate higher liquidity (many buyers and sellers, tight pricing). Wide spreads indicate lower liquidity (fewer active participants, higher trading friction).
– Spreads widen in times of low trading activity or market stress because buyers and sellers move further apart on acceptable prices.
How bid and ask are set
– They emerge from supply and demand: if buying interest rises relative to selling, both bid and ask tend to drift up; if selling pressure increases, they tend to drift down.
– Market makers and other liquidity providers post orders at prices and sizes (quantity available). Electronic matching engines then execute trades when buy and sell orders cross.
– Quotes can also show size (number of shares/contracts available) at the best bid and ask; depth beyond the best prices is shown in level II/order-book data.
Who benefits from the spread?
– Market makers and other liquidity providers earn the spread as compensation for bearing inventory and execution risk.
– Market takers pay the spread as an implicit cost for immediate execution.
– Traders with large orders or passive strategies can reduce spread cost by using limit orders (which add liquidity) rather than market orders.
Checklist before you execute
– Check the quoted bid and ask and compute the spread: Spread = Ask − Bid.
– Look at size/depth at the bid and ask — is there enough volume at those prices for your order?
– Compare the spread to the security’s price (percent spread = Spread / Midpoint * 100).
– Consider time of day (spreads can be wider at open/close or during quiet hours).
– Use limit orders to control execution price when spreads are wide or liquidity is low.
– Be aware of volatility and news that can widen spreads quickly.
– Factor in commissions and fees in addition to the spread.
Small worked numeric example
– Quote: ABC stock = 10.50
Assume the live quote for ABC stock shows:
– Bid = $10.45 (size: 500 shares) — the highest price buyers are willing to pay.
– Ask = $10.55 (size: 300 shares) — the lowest price sellers are willing to accept.
Step-by-step numbers
1) Compute the spread and midpoint
– Spread = Ask − Bid = $10.55 − $10.45 = $0.10.
– Midpoint = (Bid + Ask) / 2 = ($10.45 + $10.55) / 2 = $10.50.
– Percent spread = Spread / Midpoint × 100 = $0.10 / $10.50 × 100 ≈ 0.952%.
2) One-share round-trip cost ignoring fees (buy at ask, sell at bid)
– Immediate loss = Ask − Bid = $0.10 per share.
– That $0.10 equals ~0.952% of the midpoint.
3) Add realistic commissions/fees (example numbers)
– Suppose commission = $1.00 per trade (buy and sell). Trade size = 100 shares.
– Buy outflow = 100 × $10.55 + $1 = $1,055 + $1 = $1,056.
– Immediate sell inflow = 100 × $10.45 − $1 = $1,045 − $1 = $1,044.
– Net round-trip cost = $1,056 − $1,044 = $12 = $0.12 per share.
– Round-trip percent cost relative to midpoint = $0.12 / $10.50 × 100 ≈ 1.143%.
– Lesson: the nominal spread ($0.10) was the base friction; commissions added $0.02 per share in this example.
4) Liquidity (size/depth) and price impact example
– Ask size is only 300 shares but you want to buy 500 shares with a market or marketable limit order.
– First 300 shares fill at $10.55.
– Next available offers might be at $10.60 (assume 200 shares at that level).
– Weighted-average execution price = (300×$10.55 + 200×$10.60) / 500 = ($3,165 + $2,120) / 500 = $10.57.
– Your effective cost per share (versus the midpoint $10.50) is larger because you “walked the book.” Spread measured at top-of-book understates execution cost when depth is thin.
Practical rules based on the example
– If you intend to trade more than the displayed size, expect worse average prices; check depth-of-book or use smaller orders.
– When spreads are
– When spreads are wide relative to trade size or recent volatility, consider limit orders, slicing your order (smaller child orders), or using execution algorithms that seek liquidity or midpoint price improvement.
Checklist before submitting a trade
1. Define your execution objective: immediate fill (market) vs. price control (limit). State benchmark (e.g., midpoint, last, arrival price).
2. Check top-of-book spread and displayed depth (level‑2 / depth-of-book). Note displayed size vs. your intended size.
3. Estimate market impact: if your quantity > displayed size at the best price, expect to “walk the book.”
4. Pick order type and time-in-force: market, marketable limit, limit, IOC (immediate-or-cancel), GTC (good‑til‑canceled), etc.
5. Consider venue and order routing: lit market, dark pool, or broker algorithms.
6. Predefine a slippage tolerance and monitoring plan; cancel or adjust if market moves.
Worked numeric examples and formulas
A. Weighted-average execution price (example continued)
– You buy 500 shares. Best ask: 300 @ $10.55; next ask: 200 @ $10.60.
– Weighted-average execution price = (300×10.55 + 200×10.60) / 500 = (3,165 + 2,120) / 500 = 10.57.
B. Slippage vs. midpoint benchmark
– Midpoint = (best bid + best ask)/2 = assume $10.50.
– Absolute slippage per share = 10.57 − 10.50 = $0.07.
– Percentage slippage = (10.57 − 10.50) / 10.50 = 0.00667 = 0.667%.
C. Limit-order alternative
– If you posted a buy limit at $10.55 for 500 shares:
– You would likely fill 300 shares at 10.55 immediately; 200 shares remain unfilled.
– If the remaining 200 shares are critical, you must decide whether to raise your limit (risk worse average), wait, or route to another venue.
– Trade-off: limit protects against paying above $10.55 but may leave you partially or fully unexecuted.
Practical execution strategies
– Slice large orders into smaller child orders to reduce market impact. Example: 500 → 5 × 100 orders submitted over time or via TWAP/VWAP algorithm.
– Use midpoint or pegged orders to seek price improvement; these rest between bid and ask and may capture better prices but could be picked off in fast markets.
– Consider liquidity-seeking algorithms if size is large; they can access hidden liquidity and dark pools while minimizing signaling.
– For urgent fills, a marketable limit order (limit price slightly worse than best ask for buys) can cap worst price while favoring speed.
– Monitor fills and cancel or amend unfilled portions if market moves.
Hidden liquidity, dark pools, and payment-for-order-flow (PFOF)
– Some liquidity is not visible (hidden orders, iceberg orders, or dark pools). These venues can offer better prices but may have different execution and information characteristics.
– Brokers routing orders may receive payment-for-order-flow from venues; this can affect routing choices and execution quality. Check your broker’s execution quality disclosures.
Measuring execution quality
– Common benchmarks: midpoint, arrival price (price when order was submitted), VWAP (volume-weighted average price), and implementation shortfall (difference between decision price and realized execution).
– Implementation shortfall (absolute) = value of executed shares at execution price − value at benchmark price.
– Regularly review fills against benchmarks, and calculate average slippage and fees to evaluate brokers or algorithms.
Quick decision guide (for a small active retail order)
– Spread narrow, depth sufficient: market order or marketable limit for immediate fill.
– Spread wide, depth thin: use limit order at acceptable price, or slice order.
– Large order relative to displayed size: use algorithms or work with broker to reduce impact.
Assumptions and caveats
– Examples assume continuous, clean order book and no transaction fees or rebates. Real execution also involves commissions, exchange fees, and potential latency.
– Market behavior can change rapidly; historical depth or spreads may not persist.
Further reading
– U.S. Securities and Exchange Commission — Orders and Routing: https://www.sec.gov
– FINRA — Best Execution and Order Routing: https://www.finra.org
– NASDAQ — Bid and Ask: https://www.nasdaq.com/articles/bid-ask-what-does-it-mean
Educational disclaimer
This information is educational only and not individualized investment advice. It explains order mechanics and execution concepts; it does not recommend specific trades or brokers. Consider consulting a licensed professional for personal guidance.