Bid vs Ask: 5 Helpful Tips
It is essential for active traders to understand the difference between bid vs ask. All day trading strategies require a good understanding of the bid ask principle. This article gets into details about the bid, ask, spread, slippage with some real-live examples for day trading.
Bid vs Ask
Most brokerage trading platforms come with the standard settings of displaying the stock symbol, last price, change in % and change in $. Retail investors sometimes conclude that the last price they see in the trading platform is also the price for their stock. It is important to understand that there is a big difference between last price and bid vs ask.
The last price shown in your trading platform reflects the previous transaction price, where a buyer and a seller found together and exchanged money and shares. Those transactions are executed via a broker on stock exchanges for various securities. For simplicity, we will focus on stock trading in this article about bid vs ask.
It is essential to understand that the last price trades don't have anything to do with your trade execution. Not at all.
If you are a buyer, you want to buy a specific stock for either a specific price limit or want to get the stock for the best possible price. If you are using a limit order, you make a bid with your limit price to buy shares for that price and the number of shares defined in your order. The order book collects the offers from buyers who want to buy for a specific price and visualizes those bids on the bid side.
If you are a seller, you want to sell a specific stock for either a specific price limit or want to get the stock for the best price possible. If you are using a limit order for selling your shares, you then define the ask with your limit price to sell shares for that price with your defined number of shares. The order book collects, in this case, all the offers from sellers on the
How a Trade Gets Executed
There are 3 ways of how an order can be executed. If a buyers limit order matches a seller's limit order in price and number of shares, those market participants' orders make the deal. The buyer gets what he wants, and the seller gets what he wants for exact the parameters they used for price and number of shares.
If the limit order prices and the number of shares do not match, the orders remain in the order book as long as it takes until two parties find together.
As I mentioned above in bid vs ask, there is also a way to place an order for a specific amount of shares but without a limit. Those orders are called market orders. Market orders always get filled for the best possible price.
If a buyer wants to buy 1,000 shares of the company XYZ market, the order gets matches with the best possible seller prices on the ask side of the order book. That means that the market order from the buyer hits the limit orders from sellers. The buyer never knows what price he gets. He only knows that he gets the best possible price for the shares he wanted to buy.
If a seller wants to sell 1,000 shares of a company XYZ market, his order is matched with the best possible buy limit orders from buyers in the order book on the bid side. So if the sell market order hits the stock exchange, then the sell order gets matched on the best possible available bid orders from buyers who placed their order as a limit order on the bid side.
It is like buying on Amazon. Amazon is the seller and defines the ask. If the price doesn't matter to you, you place the market order for your favorite product and buy for the best possible price. If you are price-sensitive, you may wait until Amazon's "ask price" goes lower.
For the seller side, you can take eBay. You see, a seller offers, and he defines the asking price. Buy you are not happy with that price, and you use the option to offer him to buy the product for your favorite price defining your bid price. The seller then has the chance to accept your offer. If he does, then his ask hits your bid.
Bid Ask Spread
The price difference between bid and ask defines the so-called spread. If the bid price is $100 and the ask price is $101, then the spread bid vs ask is $1. Getting back to buying and selling with market orders means, in this case, that you buy or sell your stock accepting that you may get a $1 worse order execution than you expected. Let's say that the last price you saw was $100, the bid is $100, the ask is $101, and you order 100 shares market. In this case, your order probably gets filled for $101, which is $1 worse than you expected. This difference between the price you wanted to get and the price you finally got is called slippage. The higher the spread of stock, the higher your slippage can be.
Trading Volume and Slippage
The higher the trading volume of a stock, the lower the spread between the bid and ask and the lower the slippage when using market orders. The price of a stock does not have anything to do with the bid-ask spread. A high volume stock like AAPL can have a much smaller bid-ask spread than a penny stock. That's because of the trading volume. Therefore, spread heavy stocks should be considered to be traded with limit orders, while high-volume stocks can be ordered with market orders.
Bid vs Ask Conclusion
Traders would watch the bid price, ask price and bid ask spread closely before placing an order. The market maker executes the trades based on the existing bid and ask prices in the order book. The buyer defines what he is willing to pay per share and defines the stock price limit. The seller defines his price for what he is willing to sell his shares for. The spread is the difference between bid and ask.
We all want to buy for the lowest price possible and sell for a particular stock for the highest price. In investing, the bid ask spread is not that important. Day traders will only make money when taking the bid ask spread into consideration.