The difference between the ask price and the bid price for a marketable item is known as the bid-ask spread. The difference between the highest price a buyer is ready to pay for an item and the lowest price a seller is willing to take is known as the bid-ask spread. The person who wants to sell will get the bid price, and the person who wants to buy will pay the ask price.
Understanding Bid and Ask
Although it is fundamental to any transaction, many individual investors fail to fully understand the importance of the bid and ask. When looking at the current price of any trading securities, keep in mind you are seeing the closing price of that specific time frame. To have more information we need to look at the bid price and the ask price. In the context of a security market, bid indicates demand and ask indicates supply.
The bid price tells us how much buyers are willing to pay for a specific equity; the ask price tells us how much the sellers are willing to sell for a specific equity. For example, if the current quotation of XYZ stock includes a bid price of $35.00 and an ask price of $35.30, a trader who would like to buy the stock, would have pay the ask price of $35.30. If a trader wanted to unload the shares, he or she would have to sell them for $35.00.
Bid-Ask Spread Explained
The term "bid-ask spread" is used to describe the gap between the two prices. The market maker profit off of the difference between the bid and the ask price. When trading any type of equities, it is vital to take this into account because it represents a hidden cost.
When trading any type of equities, it is vital to take this into account because it represents a hidden cost. Using the previous example, if you buy 100 shares of XYZ stock at the ask price of $35.30 and immediately sell them at the bid price of $35.00, the transaction will cost you $30. ($35.30 - $35.00) x 100 = $30.
Even thou the stock price did not move, you have lost $30. The smaller is the spread, the cheaper is the cost for the transaction.
Generally the spread narrows when trading volume is large, which means that the security is liquid (plenty of buyers and sellers). Conversely, the spread will widen if trading volume is low for the security. This low liquidity is often time the result of fewer buyers and sellers.