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| Bid-Ask Spread |
What It Is:
The bid-ask spread (also known simply as the spread) is the difference
between a security�s bid price and its ask price.
How It Works/Example:
Let�s assume you are watching XYZ Company stock. If the bid price is $50 and
the ask price is $51.50, then the bid-ask spread is $1.50. Typically, a trader
or specialist on the floor of the New York Stock Exchange would quote the
bid-ask spread as follows:
50-51-1/2 100x50 100,000
The last number (100,000) denotes the number of XYZ Company shares traded since
the market opened. Note that online trading systems might refer to the bid-ask
spread as �BxA.�
Note that the number of shares wanted and the number of shares offered for sale may be different. This means that an investor may only be able to purchase 5,000 of a desired 10,000 XYZ Company shares at $51.50 if there are only 5,000 shares for sale at that price.
Why It Matters:
It is important to remember one key aspect of bid and ask prices: purchasers pay the ask price and sellers receive the bid price. This nuance is why securities dealers make a profit on bid-ask spreads. Their job is to buy stocks at the ask price and sell at the bid price. Thus, the size of the bid-ask spread is proportional to the size of the dealer�s profit (although not all of the spread constitutes profit for the dealer, other fees are part of the spread). Dealer profit is also one reason illiquid or lightly traded stocks tend to have larger spreads than frequently traded stocks.
Many traders and analysts scrutinize patterns in bid-ask spreads to understand what prices trigger demand for both sellers and buyers. Other traders and analysts feel that the bid-ask spread itself has little predictive value.
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