Stock will always have two prices: bid and ask. To execute a trade investor must understand the concept of bid versus ask.
Many people may not know what bid and ask means, how bid and ask price relates to the stock market, how it defines the demand and supply for a specific financial asset and how it can affect your portfolio return.
In this article we will tell you what is bid and ask price, and how they are used for trading in stocks.
What is the bid price?
Bid price is the highest price at which a buyer is willing to buy a stock through a brokerage order at a given time. The price you see in your account is on the basis of the highest bid that market participants want to pay.
As an investor you can look at the bid price before giving instruction to your broker for selling a particular stock. By looking at it, you will know the highest amount that someone is willing to pay for the stock. In this way, you will not be losing much in trade.
What is the ask price?
The ask price is the lowest price at which a seller is willing to sell a stock through a brokerage order at a given time. The ask price you see in your account is on the basis of the lowest offer that market participants want at a specific point of time. It’s often referred to as the offer price.
The difference between bid and ask price is known as spread.
If you want to buy a stock, you can look at the ask price to know the lowest price someone is willing to sell the stock for.
Remember, current market price is different from the bid and ask price. Current market price is the amount at which the last trade takes place, which means both buyer and seller agreed at a point.
However, the bid and ask price you are seeing in your stock screener, is the unmatched offers from market participants willing to trade at. Many stockbrokers will also show you the number of shares that are available for trading at both the bid and ask price.
Bid and ask prices of a stock let the traders know at what point market participants are willing to buy and sell. These prices change quickly as investors and traders act across the globe.
Remember, there is no guarantee that your order will be executed at a specified price. Each transaction in the stock market requires a buyer and seller to agree at a price.
What is bid-ask spread
The difference between stock’s bid price and ask price is known as spread. It’s used as a key parameter while buying and selling a security for the best possible price.
For example, assume for a moment that you want to buy stock of company A, which has a bid price of Rs 50 and an ask price of Rs 45 per share. In that scenario, the bid-ask spread is Rs 5. When another trader places a buy order at Rs 48 per share, the bid-ask spread is narrowed to Rs 2.
If the bid-ask spread is wider, it means stocks are not traded that often, known as less liquid stocks.
When you trade in high liquid stocks, you will not have much impact of bid-ask spread as it’s much tighter.
In other words, the bid-ask spread is low, when the security is highly traded in the stock market. On the other hand, the spread will be larger, if the stock is seldom traded in the market.
Bid-ask spread is also referred to as a negotiation in progress.
Another factor which defines bid-ask spread is demand and supply. If the stock is high in demand, then spread will be narrower. When the stock is not high in demand, the dread will be wider.
How bid and ask works in stock market
To buy or sell a stock an investor or trader places an order with his stockbroker. The broker then submits the order to the stock exchange. Each offer submitted to the broker to purchase includes a size requested and proposed purchase price.
The highest proposed purchase price is known as the bid. It’s also known as the demand side of the stock.
Similarly, a sale order also has two components: quantity offered and a proposed sale price. Lowest proposed selling price is known as ask and it represents the supply side of the stock.
Trade takes place when both bid and ask price meets the order parameters. When there is no order that bridges the bid-ask spread, no trade takes place.
Professional traders take advantage of bid and ask prices by placing different types of brokerage orders. When an order is placed, the buyer or seller has an obligation to purchase or sell their stocks at the agreed price stated in the order.
In the stock market, a buyer and seller are matched by a computer.
When the bid-ask spread is very narrower, market participants often use market order to get the stock. Market order instructs the broker to buy the stock on an immediate basis at the best available market price. As a result the trade will be executed at or near the standing bid and ask level. Remember last traded price will not be always the price at which you will get your stock by placing a market order.
If a seller wants to exit a long position or immediately enter a short position, he can sell at the current bid price. The order will get executed if the market finds a buyer.
In simple words, a market buy order will take the current ask price to execute the order. Similarly, a market sell order will take the current bid price to execute the order.
Based on the bid and ask price, traders place a bid at, below or above the current bid.
When you place a limit buy order, your order will get executed at the stated limit price or lower. For instance assume for a moment that you have placed a buy limit order at a price of Rs 50. In that scenario, your order will be executed if the price is Rs 50 or lower.
If you place a stop order, which is also known as stop-loss, you are instructing the broker to buy or sell a stock once the price hits the specific mentioned price. The level you mentioned in your order is known as stop price. You place a buy stop order where the price is higher than the current market price to limit your losses. A sell stop order is used when you want to limit your losses or to safeguard profits.
When the bid price is the same as the ask price, a trade occurs. After the trade, both orders disappear and you start seeing new un-matched bids and ask prices.
If someone placed a sell order that is bigger than the number of shares available at the current bid price, then the bid price will drop because all those shares at the current bid will get absorbed by the selling.
When a buy order received is bigger than the number of shares available at the current offer price, then the offer price will move up, because all those shares at the current offer are absorbed by the buying order.
Bid represents demand and ask represents supply for the stock.
Bid price Example
If as a trader you placed a bid at Rs 50.50 or anywhere below that price, by taking the current highest bid price as Rs 51.50, all other bids in between Rs 50.50 to 51.50 must be filled before the price drops to Rs 50.50 to fill your order.
Ask price Example
A market participant can offer to sell his stock at any price he wants. If the current offer price is Rs 40.50 per share, a market participant might place a bid at Rs 40.50 per share or anywhere above that number. If a bid at Rs 40.80 per share is placed, all other offers below it must be filled before the price moves to Rs 40.80 per share.
If it’s not getting filled, then the bid price of Rs 40.80 can be lowered.
If a market order is placed to buy right away, they get the current ask price.
Example – 3
Immagine, Mr A is selling 100 shares of Company A at Rs 50. If someone wants to buy those 100 shares of company A @ 50, then it’s simple, bid price matches with ask price, a transaction occurs and those 100 shares are no longer available to trade.
Assume that the next offer is to sell 50 shares of company A at Rs 50.30. If the market finds a buyer at that price then the transaction occurs at Rs 50.30, share price moves up from Rs 50 to Rs 50.30.
If you have more orders within the range of Rs 50.30 to 50.95, and all of them find buyers at that price, then the stock’s market price moves from Rs 50.30 to Rs 50.95. That is how price moves based on buyer and seller’s willingness to buy and sell.
Example – 4
Immagine company A has a current best bid of 200 shares at Rs 10.50 and a current best ask of 400 shares at Rs 10.80.
A trade does not take place unless a buyer meets the ask price of Rs 10.80 or a seller meets the bid price of Rs 10.50.
Assume that you placed a market bid order for 100 shares of company A. As it’s a market bid order, your bid price will automatically take Rs 10.80 per share. It will be traded until the order is fulfilled. After your order gets executed, the bid will revert to the next highest bid offer, which is Rs 10.50.
A market order buys and sells every share irrespective of the price until the order is filled. A big market order can move the price drastically and instantly.
Assume Mr X wants to purchase 1000 shares of Company A at Rs 10. Mr Y wants to sell 1,500 shares of company A at Rs 10.25.
Now the bid-ask spread is Rs 0.25, which is the difference between Rs 10 and Rs 10.25.
In this case, trade will not be executed.
If Mr Z placed a market order to buy 1,500 shares, he would get it at the asking price of Rs 10.25 from Mr Y.
Instead of 1500 shares, assume that Mr Z placed a market order to buy 2000 shares, the buyer would get 1,500 shares at Rs 10.25 from Mr Y and 500 shares at the next best offer price.
Remember market price can be filled at the current market or prevailing price.
Assume Mr B wants to purchase 1000 shares of Company A at Rs 10. Mr C wants to sell 1,500 shares of company A at Rs 10.25.
An individual Mr D has placed a limit order to sell 2000 shares at Rs 10 per share. As we have a purchase order from Mr B, 1000 shares will be immediately sold to Mr B at the existing offer of Rs 10.
Remaining 1000 shares will look for another buyer at Rs 10 per share or a price better. These 1000 shares will be traded only when Mr D will get a buyer at Rs 10 or above.
If share price stays below Rs 10 per share, Mr D will never be able to see these shares.
When you are trying to buy with a limit order, the asking price must fall to the level of your limit order or below, to get it executed.
In addition to the disclaimer below, please note, this article is not intended to provide investing or trading advice. Trading in the stock market and in other securities entails varying degrees of risk, and can result in loss of capital. Most investors and traders lose money. Readers seeking to engage in trading and/or investing should seek out extensive education on the topic and help of professionals.