In simple terms, the bid-ask spread is the difference between the maximum (bid) price a buyer is willing to pay for a stock and the minimum (ask) price a seller is willing to accept. The spread is an indicator of the liquidity of the asset.
When both buyer and seller agree, a trade (transaction) can occur. At this point the spread becomes the broker’s profit.
How It Works In Real Life
Let’s say you want to buy a block of Apple Inc. (NASDAQ:AAPLC) stock. The best bid price might be $162.08 per share and the best ask price might be $162.13. The difference ($0.05) is the spread. If you are the buyer, you will pay $162.13 per share. If you are the seller, you will receive $162.08. The broker (market maker) gets the difference ($0.05 per share).
Bid-ask spreads can vary depending on the stock and the market. Blue chip stocks that make up the Dow Jones industrial average may have a bid-ask spread of a few pennies. Some small-cap stocks could have a bid-ask spread of 50 cents or more.
Supply And Demand
Bid-ask is intertwined with the concept of supply and demand. Supply is the volume or number of shares available for sale. Demand, of course, reflects the desire of investors to pay a particular price for a given stock.
If, for example, supply is limited and demand is high, the asking price for the stock will be higher forcing the bid price up as well. If supply is plentiful and demand is low the asking price goes down and so does the bid price.
Related: WHICH STOCKS WILL SURPRISE IN 2018?
Types of Orders
There are 4 main types of orders an investor can place with a broker or market maker:
Market Order – This type of order is filled at the market or prevailing “ask” price as noted above.
Limit Order – With this type of order an investor places a limit order to sell or buy at a given bid or ask price. If that price is not met (or bettered) the sale or purchase does not take place.
Stop Order – Also known as a “Stop-Loss” order. A stop order is an order to buy or sell a stock once the price of the stock reaches a specified price, known as the stop price. When the stop price is reached, a stop order becomes a market order.
Buy-Stop Order - This is an order entered at a stop price above the current market price. Investors generally use a buy stop order to limit a loss on a stock that they have sold short. A sell stop order is entered at a stop price below the current market price. Investors generally use this to limit a loss on stock they hold.
The FinanceBoards “Broker New Order” widget lets you place a new trade order with a connected brokerage account and is included on the Trading Dashboard.