Bid-ask spread definition
Bid/ask spread
The bid/ask spread is the difference between a market’s buy (bid) price and sell (ask) price. For example, if the actual price of a market is $100, the bid price might be $101 and the ask price $99. This makes the spread $2.
Every trade that is made requires one seller to be willing to sell the market or asset at the same price that a buyer is willing to buy that same market. Therefore, the ask price can also be considered as the highest price at which a trader is willing to enter a long position (buy). The bid price is the lowest price at which a trader is willing to enter a short position (sell).
As a market’s price moves, so too will the bid and ask prices. The spread often stays fairly constant, even when the price rises or falls. An exception to this is when volatility hits and there’s added uncertainty to the markets.
Different markets will have different spreads. For example, spreads are often higher for volatile, unpredictable markets. There’s a greater risk to the broker as prices are more likely to move heavily in either direction.
To offset the increase in risk, market makers will set a higher spread by raising the buy price and lowering the sell price. If a market is experiencing a lack of liquidity, spreads may also be larger as it’s more difficult to match a buyer with a seller.
Scalpers, who look for small profits by opening and closing multiple trades over a short period, are particularly impacted by the bid/ask spread.
Every position traded will incur the cost of the spread, so the small gains made from scalping must be greater than this cost to be profitable.
For those with a longer-term outlook, the spread is far less significant as it’s assumed the profit incurred from any long-term price move will greatly outweigh the cost of the spread.
Do you buy at the bid or ask?
Assets are always bought at the ask price. The terms ask and buy in this context are interchangeable, so often the ask price will simply be called the buy price. Similarly, the bid price is the same as the sell price.
If you want to go long on a market, this means taking a buy position. You will open the buy position at the ask price. By going long on a market, you are hoping its price rises and you can close out the position at the bid price for a profit. Alternatively, if you are shorting a market, you will sell the position at the bid price and close it with a buy at the ask price.