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What is a Bid-Offer Spread?

The bid-offer spread is the difference between the price a buyer is willing to pay (bid) and the price a seller is asking (offer) for an asset. It's a key indicator of liquidity and transaction costs in financial markets. Tighter spreads often signal high liquidity, while wider spreads can indicate lower liquidity. How does this spread affect your investments? Let's examine.
Geri Terzo
Geri Terzo

A bid-offer spread is an equation used for trading stocks in the financial markets. It represents the difference between what investors are willing to pay for a stock and the price at which sellers are willing to dispose of the same security. A bid-offer spread is the difference between the buy and sell prices, and it affects the price at which a stock is trading and the types of returns that investors generate.

The bid ask process in the stock market is similar to an auction setting. A bid price reflects the most recent price at which buyers are willing to purchase shares of stock. The offer price, also referred to as an ask price, reflects the most recent value at which sellers are willing to unload a stock. The difference between these two prices represents the buy-sell spread. This amount is kept as an earned fee by the stock trader or market specialist who facilitates a trade order as a reward for increasing trading in the financial markets.

Man climbing a rope
Man climbing a rope

For example, if one large trading firm 'A' is in the market to purchase 100 shares of stock X at $10 US Dollars (USD) per share, this amount is a bid price. If another large firm 'B' is looking to sell stock X at $10.25 USD per share, this amount reflects the offer price. The difference in these prices is $0.25 USD per share, and that is the amount of the bid-offer spread.

The way that this is applied to the stock market involves a third party investor. An investor seeking to purchase shares of X can do so for $10.25 USD from trading Firm B. In the event this investor is seeking to sell shares, he can do so for $10 USD to Firm A, if he so chooses.

A bid-offer spread is based on supply and demand in a stock. The more bids there are for a particular security, the more demand, and this results in a higher stock price. If there are more offers than there are bids, supply is outweighing demand in a particular stock, and this drives the price of a security lower.

In an electronic marketplace such as Nasdaq in the United States, buyers and sellers are matched up in the stock market by computers. This cuts down on administrative costs, although market specialists still are involved in trades. These specialists post bid and offer prices on a computer, and buyers and sellers are matched electronically.

In a stock exchange where there are live market specialists, including the New York Stock Exchange (NYSE) and the London Stock Exchange (LSE), a live trader becomes responsible for matching buyers and sellers. The bid-offer spread is then determined accordingly. There also is an element of electronic trading to the NYSE and the LSE, in addition to live trading.

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