Bid-Ask Spread Flashcards
(7 cards)
What is the Bid price?
(Bids) are Buy Orders
The highest price a buyer is willing to pay for an asset. This is the price you would receive if you were to sell. Sellers receive the bid.
What is the Ask price?
(Asks) are Sell Orders
The lowest price a seller is willing to accept. This is the price you would pay if you were to buy. Buyers pay the ask.
What is the Bid-Ask spread?
Spread = Ask price - Bid price
The spread represents a “hidden cost” of trading and shows the market’s liquidity and efficiency.
Why does a spread exist? (3 parts)
- A spread is a supply and demand gap, meaning buyers want to pay less and sellers want to receive more.
- Market maker compensation, meaning the spread provides profit for market makers who provide liquidity.
- Risk management, meaning wider spreads occur during volatile periods as market makers protect themselves. Volatility and spread have a direct relationship, so if volatility increases, the spread increases.
How does high liquidity affect the spread?
High liquidity results in a tight spread. Many buyers and sellers compete, narrowing the spread.
How does low liquidity affect the spread?
Low liquidity results in a wide spread. Fewer market participants means less competition and higher costs.
How does volatility affect the spread?
During periods of uncertainty, spreads widen as market makers require more compensation for risk.
