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What is a bid-ask spread?


Eric

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The bid ask-spread is the difference between the highest price a buyer is willing to pay (bid price) for a particular asset and the lowest price a seller is willing to accept (ask price) for the same asset at a given point in time.  

1. Bid Price: This represents the utmost price a prospective buyer is eager to offer for an asset. It signifies the level of demand for the asset in the market.

2. Ask Price: Conversely, the ask price, often termed the "offer price" or "selling price," signifies the minimum price at which a potential seller is prepared to part with the asset. This reflects the extent of supply in the market.

3. Bid-Ask Spread: By calculating the difference between the ask price and the bid price, we arrive at the bid-ask spread. It serves as a vital metric of market liquidity and efficiency. A narrower spread is indicative of heightened liquidity and a strong correlation between supply and demand, while a wider spread may indicate a less liquid market or less frequent trading activity.

Imagine Company XYZ is a publicly traded stock, and currently, the bid price for XYZ shares is $30, while the ask price is $32. In this scenario, the bid-ask spread for Company XYZ would be $2 ($32 - $30).

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Hi Eric,

A bid-ask spread can be defined as the difference between the highest amount of money a buyer is willing to pay for an asset or security and the lowest price that the seller of the same asset or security is willing to accept. As an investor looking to buy a stock, you pay the asking price while the one selling the stock accepts the bid price.
The bid-ask spread is therefore the measure of the flow of demand and supply for specific assets or securities. The bid represents demand while the asking price represents the supply. The Shifts in supply and demand for the assets is therefore reflected by the level of expansion between the bid price and the asking price of a particular asset.
As a stock trader, having a comprehensive understanding of the bid-ask spread for any particular stock is vital to your success as a trader because to a significant extent, the bid-ask spread becomes the de facto measure of the market liquidity for that particular stock.
Markets that are more liquid than others are reflected by their significantly low bid-ask spreads. In a typical stock market therefore, the price takers depend on market liquidity while the counterparties who are the market makers supply the liquidity by bidding on the stocks to pay their ask prices.
The bid-ask spread differs from one security to another as well as the exchange market.
The bid ask-spread can widen or shrink significantly depending on the state of the financial markets and the global economic conditions as well.
The bid-ask spread gap widens significantly at a time when there is illiquidity; a situation whereby, there are very few willing buyers for a specific security or asset compared to the number of willing sellers for that same security or asset.
 Another instance when the bid ask-gap may widen is during tough economic times like the prevailing market conditions occasioned by the spread of the deadly novel coronavirus disease across the globe.
When there is market turmoil, very few traders are interested in buying stocks or paying asking prices beyond certain limits. At the same time, the sellers may not be willing to accept bid prices below certain set thresholds resulting in a state of illiquidity for that particular asset or security.          
 

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