Can someone explain the concept of a bid-ask spread?

Question

W WordWizard876 on 18.09.2023 Posts: 52

Alright, need a quick hand here. Been wrapping my head around this whole bid-ask spread thing. I somewhat get the idea that it's about the difference in price between the highest price that a buyer is willing to pay for an asset (bid) and the lowest price that a seller is willing to accept (ask). But the waters get murky with how it impacts trading. I mean, how exactly does a wider or a narrower spread affect the dynamics? Does the volume of trade factor in? And what about for the dealer's profit? Hoping to get a clear lowdown on this. Thanks!

Trading-Setup.com - Empower your Trades! · Accepted Answer

The bid-ask spread is the difference between the highest price a buyer is willing to pay (bid) and the lowest price a seller is willing to accept (ask).
It represents the transaction cost of trading and is a key indicator of the liquidity of the asset.
A narrow spread indicates a high liquidity, while a wide spread can signal lower liquidity and higher trading costs.

P PetPal456 on 14.10.2023 Posts: 62 · Accepted Answer

The bid-ask spread represents the costs involved in trading. If you have a wider spread, it means the trading cost is higher since you would need to cover for the difference in price. On the other hand, a narrower spread reflects a more liquid and efficient market. As for the dealer, their profit comes from this spread difference. It also pays to remember that trading volume can influence the spread - in markets with high trading volumes, the spread often tends to be narrower due to increased competition.

M MathWhiz909 on 22.12.2023 Posts: 70 · Accepted Answer

Sorry, but that's not quite accurate. The bid-ask spread isn't always a reliable indicator of market liquidity. Other factors can come into play, like market volatility or the presence of major news events affecting the asset. Plus, while dealers make money from the spread, they also risk loss when holding inventory in a volatile market, which can widen the spread as a form of risk compensation.

G GreenThumb404 on 17.01.2024 Posts: 44 · Accepted Answer

Totally hear where you're coming from. It's also worth noting that for us traders, time of day can impact the spread – with opening and closing times usually experiencing more volatility. It's all about finding the right timing and understanding these nuances.

S StarChef444 on 28.03.2024 Posts: 71 · Accepted Answer

Just to shake things up a bit, there's another side to the coin. It's not always sunshine and rainbows with narrow spreads because they can quickly expand under the right conditions. For instance, a sudden lack of liquidity or unexpected market news can instantly affect the spread, catching traders off-guard. And let's not brush off the 'last look' practice, where dealers have a final opportunity to reject or accept an order after a trader has hit the bid or ask price, which can lead to some pretty frustrating situations for traders expecting a certain spread.