What is a Bid?
A bid is the price a buyer in a market is willing to pay for a stock, bond, currency, or commodity, as well as the amount that the buyer is willing to purchase.
🤔 Understanding a bid
The bid is the highest price that a buyer in a market is willing to pay for a security, commodity, or currency. A bid stipulates both the price and the quantity that the buyer is willing to purchase. When you are placing your bid for a stock, you are competing against all other buyers in the market. You often place a bid through a broker (a person or firm who matches buyers and sellers).
Let’s say you are willing to pay $10 a share for 100 shares of the fictional Stock A. That offer is your bid. If a seller is willing to sell stock at that price, the trade will be executed.
A bid is like haggling in the world’s biggest flea market…
You finally found that one of a kind rug that’s gonna look great in your living room. The price you offer to pay is your bid. The seller may accept or reject your bid — and that will determine if the transaction happens.
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How do you read the bid and ask?
When you are looking to buy or sell a stock, you generally see two different prices — the bid and the ask. These two prices are a snapshot of what’s happening in the market. The bid and ask show you the best price to buy and sell at that particular moment.
Popular stocks can be bought and sold a lot, so the prices may change quickly.
Let’s take a look at an example of the bid / ask price for a fictional company, Acme Scuba Corporation.
- The Bid price is $100: This is currently the highest bid in the market for shares of the stock. Remember that as the name “bid” implies, there are other buyers that are bidding at a lower price. If you placed a “market order” (executed at the best available price) to sell shares, then $100 is likely the price you would receive.
- The Ask price is $105: This is currently the lowest price at which someone will agree to sell shares of the stock. This value means other sellers are asking a higher price. If you placed a “market order” to buy shares, then $105 is likely the price you would pay.
What do the ‘bid size’ and ‘ask size’ mean?
The bid and ask prices generally have another number next to them for investors who view level 1 quotes on their trading screens — often in parentheses or brackets. These represent the number of shares that investors are willing to purchase or sell at the current bid or ask price. These bid and ask sizes are usually stated in ‘board lots’ representing 100 shares each. Thus, a bid size of five would represent 500 shares.
Lot sizes that can be divided by 100 are generally called round lots. Those that can’t be — say 75 — are called odd lots. Typically, a lower-priced stock will be quoted in lots of 100 and higher-priced stocks in lots of 10 or even less.
As an example, Acme Scuba Corporation’s bid price could look like $100 (10). This number means there are 1,000 pending trades of shares at a bid price of $100. So if you wanted to sell 100 shares, then this is most likely the price you would receive. If you wanted to sell 2155 shares, then at least part of your order could be sold at $100. Depending on your order type, the remaining part of your trade could take place at a different price.
The same thing goes for the Ask price. An Ask price of $105 (20) would mean there are 2,000 pending trades at $105. If you wanted to buy 100 shares, then you would most likely pay $105 for them.
What is the role of a market maker?
The role of the market maker is to ensure that there is good liquidity in the market. Having good liquidity in the market makes buying and selling easier. They are typically banks or large financial institutions. In some cases, a market maker can also be a broker.
A market maker typically holds inventory of stock and can display bid and ask prices for a guaranteed number of shares. They can make trades for their account (principal trades) as well as for customer accounts (agency trades).
When a market maker gets the order from a buyer, they sell shares from their inventory and complete the order. Market makers earn money from the bid-ask spread — the difference between the bid price and ask price.
The liquidity they provide ensures there is enough trading volume to keep things running smoothly. Without the market makers, if you wanted to sell your stock, there may not be enough buyers in the market for you to do so.
Basically, they are the oil that keeps the market engine running smoothly.
Why is the ask price higher than the bid price?
The short answer is profit. In the stock market, there are market makers, such as banks or institutions that help ensure liquidity. This liquidity makes it easier for all of us to buy and sell efficiently.
The market maker holds an inventory of stock and makes a profit on the price difference between the bid and ask. They could not make a profit if the ask price was lower than the bid price.
Let’s say that a market maker held an inventory of shares of fictional company Tommy’s Tomatoes that they purchased for $10. They might quote an asking price of $10.05 to earn a profit. That $.05 may seem small, but when done in high volumes, it can really add up for the market makers. Consider this spread (difference in bid-ask price) compensation for the risk they are taking for holding large amounts of shares.
Alternatively, if they purchased large volumes of Tommy’s Tomatoes at $10 and quoted an ask price of $10, they would earn nothing. Even worse, at $9.95, they would be losing money.
Why are the bid and the ask so far apart?
However, there are several cases where the spread could be large — The bid-ask prices are far apart. It’s important to understand these because having a large spread doesn’t always mean there is a problem with the stock or the market it is trading in.
- Low volumes: Some stocks are not in high demand — that is, they trade in low volumes. Perhaps they are in a very niche market, or one where potential investors are waiting for more information. With low volumes, the stock is less liquid. This means there is more risk for the market maker to hold inventory of that stock.
- Volatility: Some stocks have large price movements up or down, meaning they have high volatility. When stocks are volatile, the bid-ask spread is generally larger than for less volatile stocks. Seeing this means a stock’s price is making large movements up or down.
How do you calculate the bid-ask spread percentage?
The difference in bid-ask prices is called the spread.. But how do you know if it’s a lot or a little to pay? How can you compare the spread of different stocks?
One way to do this is by calculating the bid-ask spread percentage. Making calculations helps you understand how much you are paying, in relative terms. You do this by taking the amount of the spread and dividing it by the price of the stock (spread amount/stock price).
If the bid-ask spread percentage is small, it usually means the stock is liquid, making it easier to buy and sell.
Let’s take a look at two different fictional stocks and compare their spreads to see how their trading costs line up.
- Teresa’s Tights has a bid-ask spread of $.02 and a stock price of $10. This gives a bid-ask spread percentage of $.02 / $10 = .02%.
- Chad’s Chairs has a bid-ask spread of $.2 and a stock price of $100. So the bid-ask spread percentage would be $.2 / $100 = .02%
Even though the spread on Chad’s Chairs was 10 times higher in absolute terms, it ends up being the same as a percentage.
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