In this article, we will discuss:
- Understanding Bid and Ask Price
- Difference Between Bid and Ask Price
- Bid-Ask Spread Strategies
- Bid-Ask Spread Calculation
The dynamics of stocks are complex for newcomers as well as seasoned investors. You need to be familiar with certain terms and concepts to understand how the stock market works. Bid and ask price is one of such fundamental concepts that you must be aware of regarding trading.
In this article, we will delve into understanding the concepts of bid price and ask price, analyse their differences and understand the bid-ask spread strategy.
Understanding Bid and Ask Price
Ask & bid prices reflect two essential components that drive the market and are at the centre of every stock transaction. The term "bid and ask" refers to a two-way price quote, reflecting the best potential price at which a security may be bought and sold at a given time.
A bid price is known as the maximum amount a buyer is willing to pay for a specific share of stock on a stock exchange. On the other hand, an ask is referred to as the lowest price that a seller is ready to accept for a specific stock.
Understanding bid and ask pricing in the Indian stock market is critical for making educated decisions. The bid price reflects a stock's demand, displaying the highest amount investors are ready to pay for it. In contrast, ask price reflects supply by showing the lowest price at which someone is ready to sell a stock. This interaction between buyers and sellers is the foundation of market price discovery.
Difference Between Bid and Ask Price
Even though as a trader you may feel there is just a fine line of difference between bid and ask, the reality is much more in-depth. Here is a table showcasing the ask and bid difference for your better understanding of both concepts.
This is the highest value a buyer offers for a stock.
This is the lowest value at which a seller is offering a stock or another security.
Viewpoint of Agent
For a broker, the bid price is the selling price, therefore they try to get the most from buyers.
In this case, ask price is the cost at which representatives purchase stock, and as a result, they strive to reduce cost from their end.
The rate generally remains higher than a stock's market cost.
The rate, in most cases, is generally below a stock's market cost.
The bid rate is usually the left-quoted value and is not always the same as the requested price.
This rate is located on the right half of a quotation.
A stock’s bid price is mainly used by a seller.
A buyer of a stock usually refers to its ask price.
Bid-Ask Spread Strategies
The bid-ask spread is known as the difference between the lowest price a seller will accept and the highest price a buyer is agreeing to pay for any given stock. The spread or difference is mainly associated with a security’s liquidity, which denotes how quickly and efficiently the security can be bought and sold for cash within the trading market.
When you think about the bid-ask spread trading strategies, it becomes clear that highly liquid securities have a narrow bid-ask spread. This is because the number of sellers and buyers is higher. Whereas, for less liquid securities, usually there are very few participants in the market.
Hence as a trader as well as an investor, you must consider liquidity while evaluating a stock’s bid-ask spread as it can directly impact the trading profitability.
Bid-Ask Spread Calculation
The formula to calculate the bid-ask spread is:
Bid-ask Spread = Ask Price - Bid Price
Let us show you an example to understand the formula clearly.
Suppose, the current bid price and ask price of a certain security are Rs. 100 and Rs. 105 respectively. Therefore bid-ask spread will be Rs. 5 (Rs.105 - Rs.100). This is a relatively narrow bid-ask spread since it makes it easy for both sellers and buyers to compromise.
Nonetheless, in case of bid-ask spread being high, such as Rs. 10 or above, the gap between the two is high, especially if you are buying 100 shares. Hence, most buyers and sellers will be unwilling to compromise.
This makes it hard to sell or buy the security in question. Overall, pointing out this example suggests that the bid-ask spread affects an asset’s liquidity significantly and makes it more or less liquid, depending on how wide the spread is.
Now that you have an idea of what the bid price and ask price are, it will surely help you make an informed decision while dealing in the securities market. Before you sell or buy a stock, make sure to check its bid and ask price to plan your trading appropriately.
Moreover, you can also install the "New-Gen Samco app" to check the bid price and ask price of a stock you wish to purchase. The app will give you all the details you want to know for buying or selling securities.
Frequently Asked Questions
How to determine ask and bid prices?
Market makers (high-volume traders who quote in two-sided markets) and different market forces such as supply or demand, tend to determine the ask and bid prices of a security.
What does bid and ask close together denote in the share market?
If an asset’s ‘bid’ and ‘ask’ prices are close together, it denotes a high liquidity of the asset available in the market.
What are the reasons for the high bid-ask spread?
Some of the common reasons for high bid-ask spread are as follows: high market volatility, low market liquidity, volatile market conditions, wide trading range and fewer market participants.