When you look at a stock quote, you will often see two prices instead of one. These are the bid and ask prices, and the difference between them is called the spread. Understanding the bid-ask spread is fundamental to becoming a better trader because it directly affects your trading costs.
What is the Bid-Ask Spread?
The bid-ask spread is the difference between the highest price a buyer is willing to pay (the bid) and the lowest price a seller is willing to accept (the ask). This gap represents the immediate cost of executing a trade.
Simple definition: The bid is what buyers will pay. The ask is what sellers want. The spread is the gap between them. When you buy, you pay the ask. When you sell, you receive the bid.
Bid and Ask Explained
The Bid Price
The bid is the highest price that buyers are currently willing to pay for a security. If you want to sell immediately, you will receive the bid price. Multiple buyers may be bidding at different prices, but the quote shows the best (highest) bid.
The Ask Price (Offer)
The ask is the lowest price that sellers are willing to accept. If you want to buy immediately, you will pay the ask price. The ask is sometimes called the "offer" price.
The Spread
The spread is simply the ask minus the bid. A smaller spread means lower trading costs. A larger spread means higher costs.
Example: Reading a Stock Quote
Apple (AAPL) quote:
- Bid: $185.50 (100 shares)
- Ask: $185.52 (200 shares)
- Spread: $0.02 (0.01%)
If you buy 100 shares at market, you pay $185.52 per share. If you immediately sell those shares, you receive $185.50 per share. You lose $0.02 per share ($20 total) just from the spread.
Why Does the Spread Exist?
Compensation for Market Makers
Market makers provide liquidity by always being ready to buy or sell. The spread compensates them for this service and the risk they take by holding inventory.
Supply and Demand Imbalance
When buyers and sellers have different opinions about fair value, a gap naturally forms. The spread reflects this disagreement until someone is willing to cross it.
Risk Premium
For volatile or uncertain securities, market makers demand wider spreads to compensate for the risk of rapid price changes.
What Affects Spread Width?
1. Trading Volume
High-volume stocks like Apple, Microsoft, and Amazon typically have very tight spreads, often just one cent. Low-volume stocks can have spreads of 10 cents or more.
2. Volatility
When a stock is moving rapidly, spreads widen. During earnings announcements or major news events, you will often see spreads expand significantly.
3. Market Hours
Spreads are tightest during regular market hours (9:30 AM to 4:00 PM ET) when liquidity is highest. Pre-market and after-hours trading typically has much wider spreads.
4. Stock Price
Lower-priced stocks often have wider percentage spreads. A $0.05 spread on a $10 stock (0.5%) is more costly than a $0.05 spread on a $500 stock (0.01%).
5. Market Conditions
During market stress or panic, spreads widen across all securities as liquidity providers become more cautious.
The Hidden Cost of Trading
Many traders focus on commission costs but ignore the spread, which can be more expensive. Consider this example:
Spread Cost vs Commission
You buy 500 shares of a $25 stock with a $0.10 spread:
- Commission: $0 (commission-free broker)
- Spread cost: $0.10 x 500 = $50
Even with "free" trading, you paid $50 in spread costs. For a round trip (buy and sell), that doubles to $100.
Active traders who make many trades can lose thousands of dollars to spreads over time, even with commission-free brokers.
Tight vs Wide Spreads
Tight Spreads (Good for Traders)
- Lower transaction costs
- Easier to profit on small price moves
- Found in highly liquid securities
- Common in major stocks and ETFs
Wide Spreads (Costly for Traders)
- Higher transaction costs
- Need larger price moves to profit
- Found in illiquid securities
- Common in penny stocks and small-caps
How to Minimize Spread Costs
1. Trade Liquid Securities
Stick to stocks and ETFs with high trading volume. The most popular securities have the tightest spreads.
2. Use Limit Orders
Instead of accepting the current ask price, place a limit order between the bid and ask. You might get filled at a better price.
Limit Order Strategy
Stock has bid $50.00 and ask $50.10
- Market order: You pay $50.10
- Limit order at $50.05: You might pay $50.05, saving $0.05 per share
Your limit order may not fill immediately, but you save money when it does.
3. Trade During Regular Hours
Avoid pre-market and after-hours trading when spreads are widest. Execute your trades when the market is most liquid.
4. Avoid Volatile Moments
Spreads widen around earnings, news events, and market opens. If timing is not critical, wait for spreads to normalize.
5. Check the Spread Before Trading
Always look at the bid-ask spread before placing an order. If it seems unusually wide, consider waiting or using a limit order.
Reading Spread Information
Most trading platforms display bid-ask information. Here is what to look for:
- Bid size: Number of shares buyers want at the bid price
- Ask size: Number of shares available at the ask price
- Spread amount: Dollar difference between bid and ask
- Spread percentage: Spread as a percentage of the stock price
A healthy market shows reasonable sizes on both sides. If bid or ask size is very small, the spread might widen quickly if you place a large order.
Spread Examples by Security Type
- Large-cap stocks (AAPL, MSFT): $0.01 (tight)
- Mid-cap stocks: $0.01 to $0.05
- Small-cap stocks: $0.05 to $0.25
- Penny stocks: $0.01 to $0.10+ (high percentage)
- Options: $0.01 to $0.50+ depending on liquidity
- ETFs (SPY, QQQ): $0.01 (very tight)
Track Your Trading Costs
Pro Trader Dashboard helps you monitor all trading costs including spreads and slippage. See exactly what you are paying on every trade.
Summary
The bid-ask spread is a fundamental concept every trader must understand. It represents the immediate cost of trading and varies based on liquidity, volatility, and market conditions. By trading liquid securities, using limit orders, and avoiding volatile periods, you can minimize your spread costs and keep more of your profits.
For deeper understanding of market mechanics, explore our guides on market makers and order books. If you want to learn about other order types, check out limit orders and market orders.