Bid vs. Ask: What’s the Difference?

Buying and trading stocks are considerably easier than most would-be investors might think. However, while buying and selling stock is simple, there are still a few concepts and keywords you should know before you start your stock investment journey. For example, you should learn the difference between a the Bid vs. Ask price and understand the importance of the bid-ask spread to optimize all of your trades prior to making your first investment.

What Is Bid vs. Ask?

Bid vs. Ask 1024x683 - Bid vs. Ask: What's the Difference?
Photo by Austin Distel on Unsplash

When investors purchase a stock share or an options contract, they place a bid or the highest amount of money they’re willing to pay for the stock. Meanwhile, the seller offers an ask or the lowest amount of money they’re willing to accept for the stock. Essentially, a bid is a purchase offer while an ask is a sale offer. You’ll see these terms frequently as you begin making trades.

What Is a Spread?

Usually, the bid and the ask are different. The amount between the bid and the ask for a stock share is known as the bid-ask spread. Most of the time, the ask will be higher than the bid. In many cases, the bid-ask spread goes to the broker who manages the trade as payment for their services. 

Calculating the bid-ask spread by dollar amount or by percentage can help you determine how much you’ll end up spending in total on a trade. To figure out the dollar amount, subtract the bid from the ask. Multiply that number by however many shares you’re trading. To find the percentage of the total transaction, use this formula:

bid-ask spread % = (ask – bid) / ask * 100

For example, say a stock has an asking price of $20 and a bid price of $19. The bid-ask spread percentage would be: 

5% = (20 – 19) / 20 * 100%

The bid-ask spread percentage is 5% of the total cost of the transaction.

How the Bid-Ask Spread Relates to Liquidity

The size of the spread between the bid and the ask depends on the liquidity of the stock in question. Liquidity, or the ability to turn an asset into cash quickly, changes from security to security. Those stocks with higher liquidity often have much smaller bid-ask spreads than those with lower liquidity.

Elements of a Bid-Ask Spread

Several factors can impact the bid-ask spread:

  • Liquidity: Those stocks with high liquidity tend to have lower bid-ask spreads, while those with low liquidity have higher bid-ask spreads. 
  • Supply and demand: Securities in high demand with frequent trades tend to have a smaller bid-ask spread than those that trade infrequently. 
  • Type of security: Investors can execute bid-ask trades with any kind of stock, but this trading style is most common in commodities and foreign exchanges.

For new and seasoned investors alike, understanding how bid-ask spread impacts overall trade costs is essential. Assess the dollar amount and percentage to see how much your bid-ask trades truly cost before making a move.