Bid-ask spread is the difference between the highest price which a buyer is willing to pay for an asset as well as the lowest price that a seller is willing to accept.
What Is a Bid-Ask Spread?
A bid-ask spread is a difference between the highest price which a buyer is willing to pay for an asset as well as the lowest price that a seller is willing to accept for an asset. The spread is the transaction cost, where price takers can buy at the asking price and sell at the bid price; however, the market maker buys at the bid price and sells at the asking price. The bid actually represents demand, while the ask represents the supply for an asset. The bid-ask spread is the measurement of market liquidity.
Going even further, the bid-ask spread is dependent on the liquidity, which means the more liquid a stock is, the tighter the spread it has. When an order is placed, the buyer or seller has an obligation to purchase or even sell their shares at the agreed price, and different types of orders can trigger different order placements.
Bid-ask spread can be high due to a multitude of factors. One of the key factors that play a role is liquidity, and when there is a significant amount of liquidity within a market for security, the spread is tighter as a result of this. Stocks that are traded heavily have a smaller bid-ask spread. A bid-ask spread can be larger for unknown or unpopular securities within a specific day.
In other words, for the bid-ask spread to be a success, the traders have to be willing to take a stand as well as walk away in the bid-ask process through limit orders.