Adjust Text Size

What is the Bid-Ask Spread?

Written by Nickel - 5 Comments

It’s widely recognized that the transaction costs incurred by investors are made up of two primary components: brokerage fees (i.e., commissions), and the bid-ask spread. While most people are familiar with brokerage fees, fewer people are familiar with the concept of the bid-ask spread.

The bid-ask spread, sometimes referred to as the bid-offer spread, refers to the difference between the prevailing price at which you could sell a particular investment (the bid price) and the price at which you could buy it (the ask price). In other words, we’re talking about the highest price that a buyer is willing to pay for an asset, and the lowest price that a seller is willing to accept.

The difference between the bid price and the ask price is the referred to as the “spread,” and it goes to the so-called “market maker.” Market makers are firms that provide market liquidity and help to smooth out buyer/seller imbalances (and ultimately profit) by standing ready to buy assets at the bid price and to sell them at the ask price.

The reason that he bid-ask spread matters to people like you and me is that whenever you make a trade, you’re instantaneously “in the hole” by a small amount, even before we consider brokerage fees. It’s worth noting that the bid-ask spread is typically larger on thinly-traded (i.e., relatively illiquid) investments such as micro-cap stocks as compared to more widely traded (i.e., relatively liquid) investments.

Published on October 13th, 2009 - 5 Comments
Filed under: Saving & Investing

About the author: is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!

Related articles...

» Sweat Equity: Improving our Landscaping
» Should Dividend Payment Dates Matter?
» Roth IRAs Maxed out for 2006
» Money Poll #1: Budgeting
» Life’s Too Short to Drink Cheap Beer
» How to decide whether to pay off debt now or later
» Current Debt Load Poll Results
» The Fine Art of ‘Reverse Budgeting’

Was this article useful? Please sign up to receive our content via e-mail:

You will receive only the daily updates, and can unsubscribe at anytime.

5 Responses to “What is the Bid-Ask Spread?”

  1. 1
    BG Says:

    Not sure I understand the “market maker”’s role, but there is no such thing as a free-lunch, so I bet he gets burned every now and again (if the markets were “fair”).

    Also, if I call my broker and tell him to sell XX shares for $10, there really is no “spread” that I’ll lose, because I set the price right? The only way my transaction goes through is if someone comes up to meet my price (and I’m only out the brokerage fee).

  2. 2
    Steve Says:

    This is true if you’re using a market order. However, if you are setting a limit order at the current end of the spread, then someone else can “pay” the spread cost. For example, if bid is 10 and ask is 10.01, you can set a buy limit at 10, which won’t get immediately filled like a market order. However, if someone else then comes and puts in a sell order at market, they could sell it to you at 10 without changing the bid-ask. Thus, you just bought at 10 and can still sell at 10.

    As a basic concept, yes, but you simplified it a little too much.

  3. 3
    Bill Says:

    Not necessarily true. Example:

    You want to buy 5 shares of XYZ stock at $10 a share. A seller is willing to sell you 5 shares of XYZ stock at $9.98 a share. You get your 5 shares of XYZ stock, the seller gets their money, and the broke gets the 2 cent difference.

  4. 4
    Robert Says:

    Never heard of the bid-ask spread, but interesting article nevertheless.

  5. 5
    GM Says:

    Good article. How about another one that lays out step by step how to buy and sell options using a broker’s web site.

Leave a Reply

Because rates and offers from advertisers shown on this website change frequently, please visit referenced sites for current information. This website may be compensated by companies mentioned through advertising, affiliate programs or otherwise.
FiveCentNickel User Survey