Bid-Ask Spread
Definition
The bid-ask spread is the difference between the highest price a buyer is willing to pay (bid) and the lowest price a seller is willing to accept (ask) for a security.
Explanation
The bid price represents the maximum amount a buyer is willing to pay, while the ask price is the minimum a seller will accept. The spread is essentially the cost of executing a trade, and it narrows or widens based on the asset's liquidity and trading volume.
High-liquidity assets like large-cap stocks typically have very narrow spreads (pennies), while illiquid assets like small-cap stocks or exotic options can have wide spreads. Market makers profit from the spread and help maintain market liquidity by continuously quoting both bid and ask prices.
A wider spread often indicates higher risk, lower liquidity, or increased market volatility. Traders should consider spreads when calculating transaction costs, especially for frequently traded positions.
Example
AAPL stock shows a bid price of $178.50 and an ask price of $178.53. The bid-ask spread is $0.03, meaning an investor buying and immediately selling would lose $0.03 per share to the spread.