What Is Bid and Ask Price in Trading: A Complete Guide

When you first enter the world of trading and investing, you'll quickly encounter two fundamental terms that form the backbone of every transaction: bid and ask prices.

The bid is the highest price buyers are willing to pay, while the ask (or offer) is the lowest price sellers will accept. You sell at the bid and buy at the ask and the bid minus the ask is known as the spread. The spread is also a built in trading cost for all financial markets.

These concepts are essential to understanding how financial markets operate, yet many new investors find them confusing or overlook their significance. Whether you're trading stocks, bonds, currencies, or other securities, comprehending bid and ask prices will help you make smarter decisions and better manage your trading costs.

Keep reading to learn more.

Bid and ask price definitions

At its most basic level, the bid price represents the highest price that a buyer is currently willing to pay at any given moment. Think of it as the demand side of the market equation. When you want to sell, you'll sell at the bid price, this is what buyers are offering to pay for the asset at that moment.

Conversely, the ask price (sometimes called the "offer price") is the lowest price that a seller is willing to accept for that same asset. This represents the supply side of the market. When you want to buy, you'll pay the ask price.

These two prices exist simultaneously in the market all the time and are constantly fluctuating based on real time supply and demand. The relationship between them creates what's known as the spread, which is simply the difference between these two prices.

How bid and ask prices work in trading

To truly grasp this concept, let's walk through a practical example. Imagine you're interested in purchasing shares of ABC Company. When you look at the quote, you see:

• Last traded price: $75.00
• Bid price: $74.80
• Ask price: $75.20

Here's what this information tells you: The last transaction that occurred was at $75.00, but that's historical data. Right now, the highest price any buyer is willing to pay is $74.80, while the lowest price any seller will accept is $75.20. The difference between these two prices is $0.40 and that is the spread.

If you decide to buy 100 shares using a market order (an order that executes immediately at the best available price), you'll pay the ask price of $75.20 per share, for a total of $7,520. Similarly, if you wanted to sell shares immediately, you'd receive the bid price of $74.80 per share.

This is important as retail traders are typically "market takers," meaning they must accept the prices currently available in the market. When buying, you pay what sellers are asking; when selling, you receive what buyers are bidding.

How to read a bid and ask price quote

In the financial markets, quotes are typically shown as bid / ask, and the primary unit of price movement is measured in terms of pips, in forex, and ticks in stocks. Here’s some examples:

Forex

For the EUR/USD currency pair, you might see a quote of 1.09320 / 1.09340.

• Bid Price: 1.09320
• Ask Price: 1.09340
• Spread: The difference is 0.00020, which equals 2.0 pips.

Stocks

For ABC company's stock, you might see a quote of $50.55 / $50.60.

• Bid Price: $50.55
• Ask Price: $50.60
• Spread: The difference is $0.05

Indices

For stock market indices, you might see a quote of 10890.00 / 10891.00.

• Bid Price: 10890.00
• Ask Price: 10891.00
• Spread: The difference is 1.00, or a full index point

The role of market makers

You might be wondering who sets the bid and ask price? The answer lies with market makers, specialized traders or institutions that facilitate trading by continuously providing both buy and sell quotes. These entities play a vital role in maintaining market liquidity and ensuring that traders can trade when they want to.

Market makers profit from the spread as they buy assets at the bid price and sell them at the ask price, keeping the difference as compensation for providing liquidity and taking on risk. For example, if a market maker buys 1,000 shares at the bid price of $74.80 and then sells them at the ask price of $75.20, they earn $400 (minus any of their own transaction costs).

While this might seem like market makers are simply taking money from regular investors, they actually provide an essential service. Without market makers, you might have to wait much longer to find someone willing to buy your shares at a reasonable price, or you might struggle to purchase shares when you want them. Market makers ensure that there's almost always someone on the other side of your trade. So you can buy or sell whenever you want to.

The spread is a trading cost

The spread represents an implicit cost that every trader pays with each transaction. This cost exists regardless of whether the price moves up or down. The market price also has to move the distance of the spread for the trade to reach the break-even price, minus any commissions.

Suppose you buy shares at an ask price of $91. Even if the stock's value increases by 5%, you won't capture that entire gain. If the new bid price is $94.50 and the new ask price is $95.55, you'll sell at the bid price of $94.50. Your actual profit is $3.50 per share, not the full $4.55 increase that a simple 5% calculation would suggest. The spread has effectively reduced your gain.

Calculating the spread percentage helps you understand the true cost of trading:

Spread Percentage = (Ask Price - Bid Price) / Ask Price × 100

Using our earlier example with a bid of $74.80 and ask of $75.20:

Spread Percentage = ($75.20 - $74.80) / $75.20 × 100 = 0.53%

This means you're immediately paying about half a percent just to enter and exit the position, before considering any other fees or commissions. If you buy at the ask price and immediately sell at the bid price, before the price has moved by the distance of the spread, you will realize a loss.

Tight vs wide spreads

The width of the bid-ask spread provides valuable information about an asset's liquidity, risk level, and trading costs. Understanding these can significantly improve your trading decisions.

Tight Spreads

Major currency pairs, like the EURUSD, typically have very narrow spreads, often just 0.1 pips and on occasion, as low as 0.0 pips. For example, the EURUSD might have a bid of $1.30000 and an ask of $1.30001, creating a spread of only 0.1 pips.

Tight spreads indicate several positive market characteristics:

• High trading volume: Many buyers and sellers are actively trading the asset
• Strong liquidity: You can easily enter or exit positions without significantly impacting the price
• Market consensus: Buyers and sellers generally agree on the assets value
• Lower transaction costs: The cost of trading is minimal relative to the investment size
• Reduced risk: The price doesn't have to move as far to cover the distance of the spread

Wide Spreads

On the other hand, exotic currency and less frequently traded pairs often have wide spreads, sometimes 10 pips or more, representing a significantly greater percentage of the asset's price.

Wide spreads signal potential negative characteristics:

• Low trading volume: Fewer lots might trade daily
• Poor liquidity: Finding a buyer or seller at your desired price may be difficult
• Market disagreement: Significant uncertainty exists about the assets value
• Higher transaction costs: The spread alone can eat significantly into your potential profits
• Increased volatility: Prices may swing more dramatically

Wide spreads become even more pronounced during periods of market turmoil, economic uncertainty, or when high impact or negative news affects a particular asset. During these times, spreads can widen to compensate for increased uncertainty and risk, making trading execution even more expensive.

Factors that determine bid and ask prices

Bid and ask prices aren't set by any single individual or broker, they're determined by the collective forces of market supply and demand.

Several key factors influence these prices:

Supply and demand

At the most fundamental level, when more traders or investors want to buy an asset, rather than sell it, both the bid and ask prices will rise. Conversely, when more traders or investors want to sell than buy, prices drift downward. This continuous interplay between buyers and sellers creates the price discovery process that makes markets function and trading possible.

Trading volume and activity

Assets with higher trading volumes generally have tighter spreads because there's more competition among buyers and sellers. When thousands or millions of lots or shares trade hands, the market becomes more efficient, and the gap between what buyers will pay and sellers will accept gets tighter.

Market volatility

During periods of high volatility, whether due to earnings announcements, economic data releases, or broader market turbulence, spreads typically widen. This occurs because traders and market makers face greater uncertainty and risk, so they demand more compensation (a wider spread) for providing liquidity.

Asset type and market structure

Different markets and asset types have characteristically different spread widths. Forex markets typically have the tightest spreads for major currency pairs, because these markets are extremely liquid with massive trading volumes. Stock markets fall in the middle, while some bond markets may have wider spreads due to lower liquidity.

How trading orders types interact with bid and ask prices

Understanding bid and ask prices empowers you to make strategic decisions about how you execute trades. The two primary order types have very different implications:

Market orders

A market order instructs your broker to buy or sell immediately at the best available price. When you place a market buy order, you'll pay the current ask price; when you place a market sell order, you'll receive the current bid price.

Market orders provide certainty of execution but not certainty of price. They're best used when:

• You need to enter or exit a position quickly
• The asset is highly liquid with a tight spread
• The exact price is less important than executing the trade

Limit orders

A limit order allows you to specify the exact price at which you're willing to buy or sell. A buy limit order will only execute at your specified price. Limit orders give you price control but not execution certainty, as your order might not fill if the market doesn't reach your price. Limit orders and best used when:

• To enter the market at a predetermined price level
• You're patient and can wait for your desired price

Key takeaways for bid and ask in trading

Understanding bid and ask prices is fundamental for trading and investing. Here are the essential points to remember:

1. Always consider the spread as a cost: The bid and ask spread is an immediate expense that affects every trade.
2. Liquidity matters: assets with tight spreads are generally easier, cheaper, and more stable..
3. Use appropriate order types: Market orders provide speed but no price control; limit orders provide price control but no execution guarantee.
4. Monitor spread changes: Widening or narrowing spreads can signal changing market conditions.

Conclusion

The bid and ask prices form the fundamental structure of how markets operate and how every trade is executed. By thoroughly understanding bid and ask dynamics, you'll be better equipped to evaluate trading opportunities, manage costs, assess liquidity and risk, and ultimately make more better informed trading decisions. Take the time to check bid-ask spreads before executing trades, use limit orders when appropriate, and favor more liquid assets with tight spreads if you want to trade frequently.

If you would like to practice and apply this knowledge, register a demo or live account and login to the trading platform.

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TIOmarkets offers an exclusively execution-only service. The views expressed are for information purposes only. None of the content provided constitutes any form of investment advice. The comments are made available purely for educational and marketing purposes and do NOT constitute advice or investment recommendation (and should not be considered as such) and do not in any way constitute an invitation to acquire any financial instrument or product. TIOmarkets and its affiliates and consultants are not liable for any damages that may be caused by individual comments or statements by TIOmarkets analysis and assumes no liability with respect to the completeness and correctness of the content presented. The investor is solely responsible for the risk of his/her investment decisions. The analyses and comments presented do not include any consideration of your personal investment objectives, financial circumstances, or needs. The content has not been prepared in accordance with any legal requirements for financial analysis and must, therefore, be viewed by the reader as marketing information. TIOmarkets prohibits duplication or publication without explicit approval.

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Chris Andreou

Experienced independent trader

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