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's a fundamental concept in trading that represents a real cost beyond commissionsâand understanding it is essential for anyone trading stocks, ETFs, options, or other securities.
In this comprehensive guide, we'll explore how the bid-ask spread works, why it exists, what it tells us about market liquidity, how different securities have different spreads, and how you can minimize spread costs in your trading.
đ Table of Contents
- What is the Bid-Ask Spread?
- How the Spread Works
- Calculating the Spread
- What Affects Spread Size
- Spreads by Security Type
- The Spread as a Liquidity Indicator
- Market Makers and the Spread
- Order Types and the Spread
- How to Minimize Spread Costs
- FAQ: Frequently Asked Questions
1. What is the Bid-Ask Spread?
Every tradeable security has two prices at any given moment: what buyers are willing to pay (bid) and what sellers are willing to accept (ask). The gap between them is the spread.
| Term | Definition | What It Means for You |
|---|---|---|
| Bid Price | Highest price buyers are offering to pay | Price you receive if you SELL immediately |
| Ask Price | Lowest price sellers will accept | Price you pay if you BUY immediately |
| Spread | Difference between ask and bid | Your implicit trading cost |
| Mid Price | (Bid + Ask) á 2 | Theoretical "fair value" between the two |
Basic Spread Calculation
Spread = Ask Price - Bid Price
$100.05 (Ask) - $100.00 (Bid) = $0.05 spread
2. How the Spread Works
The spread represents an immediate cost of trading. If you buy at the ask and then immediately sell at the bid, you lose the spreadâeven if the underlying price hasn't moved at all.
Simple Example
| Action | Price | Your Position |
|---|---|---|
| Current bid/ask | $99.95 / $100.05 | Spread = $0.10 |
| You buy 100 shares | Pay $100.05 (ask) | Cost: $10,005 |
| Price doesn't move | $99.95 / $100.05 | No change in market |
| You sell immediately | Receive $99.95 (bid) | Proceeds: $9,995 |
| Result | Loss: $10 (the spread Ă 100 shares) |
đĄ The Hidden Cost
Even with "zero commission" brokers, the spread is always a cost. On a $0.10 spread trading 1,000 shares, you immediately lose $100 the moment you enter the trade. For frequently traded stocks like Apple, the spread might be just $0.01. For thinly traded small caps, it could be $0.50 or more.
3. Calculating the Spread
The spread can be expressed in absolute dollars or as a percentage:
Spread Percentage Formula
Spread % = (Ask - Bid) á Ask à 100
($100.05 - $100.00) á $100.05 à 100 = 0.05%
Spread Comparison Examples
| Stock | Bid | Ask | $ Spread | % Spread | Assessment |
|---|---|---|---|---|---|
| Large-cap (e.g., AAPL) | $185.00 | $185.01 | $0.01 | 0.005% | Extremely tight |
| Mid-cap stock | $45.00 | $45.05 | $0.05 | 0.11% | Normal |
| Small-cap stock | $12.00 | $12.15 | $0.15 | 1.25% | Moderately wide |
| Thinly traded stock | $8.50 | $9.00 | $0.50 | 5.56% | Very wideâcaution |
| Penny stock | $0.45 | $0.55 | $0.10 | 18.2% | Extremely wide |
Round-Trip Cost
The "round-trip" cost is the total spread cost for buying and then selling:
| Trade Size | $0.01 Spread | $0.10 Spread | $0.50 Spread |
|---|---|---|---|
| 100 shares | $1 | $10 | $50 |
| 500 shares | $5 | $50 | $250 |
| 1,000 shares | $10 | $100 | $500 |
| 5,000 shares | $50 | $500 | $2,500 |
4. What Affects Spread Size
| Factor | Impact on Spread | Why |
|---|---|---|
| Trading Volume | High volume â Tight spread | More buyers and sellers competing |
| Market Cap | Large cap â Tight spread | More institutional interest, liquidity |
| Volatility | High volatility â Wide spread | Market makers need compensation for risk |
| Time of Day | Pre/post market â Wider spread | Fewer participants, less liquidity |
| Market Conditions | Stress/fear â Wider spread | Uncertainty, reduced market making |
| News Events | Earnings, announcements â Wider | Uncertainty about fair price |
| Exchange/Venue | Varies | Different liquidity at different venues |
â Tight Spread Conditions
- High trading volume
- Large-cap, well-known stocks
- Normal market hours (9:30-4:00)
- Calm market conditions
- Popular ETFs (SPY, QQQ)
- No pending news/earnings
â ď¸ Wide Spread Conditions
- Low trading volume
- Small-cap, obscure stocks
- Pre-market or after-hours
- Market panic or volatility spike
- Thinly traded ETFs
- Right before earnings release
5. Spreads by Security Type
| Security Type | Typical Spread | Notes |
|---|---|---|
| Mega-cap stocks (AAPL, MSFT) | $0.01 (0.01%) | Extremely liquid |
| Large-cap stocks | $0.01-$0.03 (0.02-0.05%) | Very liquid |
| Popular ETFs (SPY, VOO, QQQ) | $0.01 (0.01%) | Often tighter than underlying stocks |
| Mid-cap stocks | $0.02-$0.10 (0.05-0.20%) | Moderate liquidity |
| Sector/thematic ETFs | $0.01-$0.05 (0.02-0.10%) | Varies by popularity |
| Small-cap stocks | $0.05-$0.25 (0.25-1%) | Less liquidity |
| International ETFs | $0.01-$0.10 (0.02-0.15%) | Wider when foreign markets closed |
| Bond ETFs | $0.01-$0.05 (0.01-0.05%) | Generally liquid |
| Options | $0.05-$0.50+ (1-5%+) | Can be very wide, especially illiquid strikes |
| Penny stocks (<$5) | $0.05-$1.00+ (1-20%+) | Extremely wideâsignificant cost |
â ď¸ Options Spreads Can Be Enormous
Options on illiquid stocks or far out-of-the-money strikes can have spreads of 20-50% or more. A $0.50 option with a $0.30 bid and $0.50 ask has a 40% spread. This makes frequent options trading extremely costly and is why many options traders use limit orders exclusively.
6. The Spread as a Liquidity Indicator
The spread tells you about market liquidityâhow easily you can buy or sell without moving the price:
| Spread Size | Liquidity Level | What It Means |
|---|---|---|
| < 0.05% | Excellent | Easy to trade, minimal cost impact |
| 0.05% - 0.20% | Good | Normal trading conditions |
| 0.20% - 0.50% | Moderate | Consider using limit orders |
| 0.50% - 1.00% | Low | Significant cost; trade carefully |
| > 1.00% | Very Low | High cost; avoid market orders |
Depth of Book
Beyond just the best bid and ask, the "depth of book" shows how many shares are available at each price level:
| Bid Price | Bid Size | Ask Price | Ask Size | |
|---|---|---|---|---|
| $99.98 | 500 | $100.00 | 1,000 | |
| $99.97 | 800 | $100.01 | 2,000 | |
| $99.96 | 1,200 | $100.02 | 1,500 | |
| $99.95 | 2,000 | $100.03 | 800 |
Best bid $99.98 (500 shares), Best ask $100.00 (1,000 shares). Spread = $0.02
đ Why Depth Matters
If you want to buy 5,000 shares but only 1,000 are offered at the best ask ($100.00), you'll "walk up" the order book, paying $100.01, $100.02, etc. for the rest. This is called "market impact"âlarge orders move the price against you. Deep books with lots of size at each level can absorb large orders without much price movement.
7. Market Makers and the Spread
Market makers are firms that continuously quote bid and ask prices, providing liquidity to the market. They profit from the spread.
| Aspect | How Market Makers Work |
|---|---|
| Role | Provide continuous two-sided quotes (bid and ask) |
| Profit | Buy at bid, sell at askâearn the spread |
| Risk | Hold inventory that can move against them |
| Competition | Multiple market makers compete, tightening spreads |
| Regulation | Must maintain orderly markets, post quotes |
Why Market Makers Widen Spreads
| Situation | Why Spreads Widen |
|---|---|
| High volatility | Greater risk of prices moving against inventory |
| Low volume | Fewer trades to earn spread; need wider margin per trade |
| News/uncertainty | Don't know fair price; protect against information asymmetry |
| End of day | Don't want overnight inventory risk |
| Market stress | May reduce quote size or withdraw entirely |
8. Order Types and the Spread
The order type you use determines how you interact with the spread:
| Order Type | How It Works | Spread Impact |
|---|---|---|
| Market Order | Execute immediately at best available price | Pay the spread (buy at ask, sell at bid) |
| Limit Order | Only execute at your specified price or better | Can potentially avoid the spread |
| Marketable Limit | Limit order at current ask (buy) or bid (sell) | Same as market order but with price protection |
| Stop Order | Becomes market order when trigger hit | Pays spread (possibly wider in volatile moments) |
| Stop-Limit | Becomes limit order when trigger hit | May not execute if price moves too fast |
Market Order vs. Limit Order Example
| Scenario | Market Order | Limit Order at $99.98 |
|---|---|---|
| Current quote | Bid: $99.95 / Ask: $100.00 | |
| You want to buy 100 shares | ||
| Execution | Immediate at $100.00 | Waits for ask to drop to $99.98 |
| Cost | $10,000 | $9,998 (if filled) |
| Risk | Guaranteed fill | May not fill if price rises |
đĄ When to Use Each Order Type
Market orders: Use when execution is more important than price (need to exit now, highly liquid stocks). Limit orders: Use when price is more important than timing (wide spreads, less urgent trades, illiquid securities). Most traders use limit orders for everything except urgent situations.
9. How to Minimize Spread Costs
| Strategy | How It Helps | When to Use |
|---|---|---|
| Use limit orders | Control your execution price | Almost always |
| Trade liquid securities | Tighter spreads on popular stocks/ETFs | When choosing what to trade |
| Trade during market hours | Tighter spreads 9:30 AM - 4:00 PM ET | Avoid pre/post-market if possible |
| Avoid volatile moments | Spreads widen during news, earnings | Wait for volatility to settle |
| Use mid-point orders | Some brokers offer orders between bid/ask | When available for your security |
| Trade less frequently | Fewer trades = fewer spread costs | Long-term investors |
| Consider total cost | Wide spread may outweigh other savings | Comparing similar securities |
Spread Cost Calculator
| Trading Frequency | Annual Trades | Avg Trade Size | $0.02 Spread Cost | $0.10 Spread Cost |
|---|---|---|---|---|
| Buy & hold investor | 4 | $5,000 | $4/year | $20/year |
| Monthly rebalancer | 24 | $2,000 | $24/year | $120/year |
| Swing trader | 100 | $5,000 | $100/year | $500/year |
| Active day trader | 1,000 | $10,000 | $2,000/year | $10,000/year |
*Assumes round-trip spread cost per trade. Actual costs depend on specific securities traded.
â ď¸ The More You Trade, The More Spreads Matter
For a buy-and-hold investor making a few trades per year, spread costs are minimal. For an active trader making hundreds or thousands of trades, spread costs can be the single largest expenseâfar exceeding commissions. This is one reason why most active traders underperform: they're fighting not just the market but also the spread on every trade.
10. FAQ: Frequently Asked Questions
Why is the ask always higher than the bid?
The ask (what sellers want) is always higher than the bid (what buyers will pay) because no rational seller would accept less than buyers are offering, and no rational buyer would pay more than sellers are asking. If they overlapped, a trade would immediately occur and clear those orders. The spread exists because buyers and sellers disagree about fair value within a small range.
Is the spread a fee I pay to my broker?
No. The spread is not a broker feeâit's the difference between buyer and seller prices in the market. The spread goes to whoever takes the other side of your trade, typically a market maker. Your broker may separately charge commissions (though many now offer commission-free trading). However, some brokers receive "payment for order flow" from market makers, which is related toâthough separate fromâthe spread.
Can I buy at the bid or sell at the ask?
Yes, but not instantly. If you place a limit order to buy at the bid price, your order joins other buyers waiting at that price. You'll only get filled if a seller decides to accept that price. Similarly, a limit order to sell at the ask waits for a buyer to accept your price. There's no guarantee of executionâthe price might move away from you. This is the trade-off: market orders guarantee execution but pay the spread; limit orders might avoid the spread but might not execute.
Why do spreads widen in pre-market and after-hours?
Extended-hours trading has far fewer participants than regular market hours. With fewer buyers and sellers, there's less competition to offer the best prices, and market makers quote wider spreads to compensate for the higher risk and lower volume. A stock that trades with a $0.01 spread during the day might have a $0.10 or wider spread in pre-market. Unless you have a specific reason, it's usually better to trade during regular hours.
Do ETFs have tighter spreads than the stocks they hold?
Often, yes. Popular ETFs like SPY can trade with penny spreads because of their massive trading volume and the arbitrage mechanism that keeps ETF prices aligned with underlying holdings. However, thinly traded or specialized ETFs can have wider spreads than their underlying holdings. Check the spread before trading any ETFâsome niche products have surprisingly wide spreads.
How do I see the bid-ask spread?
Most brokers and financial websites show bid and ask prices on quote screens. Look for "Bid" and "Ask" (or "Offer"). Some platforms show Level 2 quotes with the full order book depth. If you only see one price, it's usually the last trade price, not the current bid/ask. Real-time quotes generally require a brokerage account; free websites may have delayed data.
Should I always use limit orders?
For most retail investors, yesâespecially for less liquid securities. The main exception is when you need immediate execution (emergency sell, time-sensitive opportunity) and the spread is tight. For liquid large-cap stocks with penny spreads, market orders are often fine. For anything with a wider spread, limit orders are almost always worth the extra effort. The worst-case scenario with a limit order is not getting filled; the worst case with a market order in a wide-spread stock is getting a terrible price.
Conclusion
The bid-ask spread is one of the most importantâand often overlookedâcosts of trading. While commissions have fallen to zero at many brokers, the spread is always present, representing the real cost of market participation. Understanding spreads helps you trade more effectively and evaluate the true cost of your investment decisions.
Key takeaways:
- Spread = Ask price (buy) minus Bid price (sell)
- You pay the spread every time you trade (buy at ask, sell at bid)
- Tight spreads indicate liquid markets; wide spreads signal illiquidity
- Large-cap stocks and popular ETFs typically have penny spreads
- Small-caps, options, and penny stocks can have very wide spreads
- Spreads widen during volatility, news, and off-hours trading
- Market makers earn the spread by providing liquidity
- Limit orders let you control price; market orders pay the spread
- Frequent traders lose more to spreads than buy-and-hold investors
- Always check the spread before trading, especially in less liquid securities
For long-term investors, spread costs are relatively minor. But for active traders, understanding and minimizing spread costs can be the difference between profitability and loss. The spread is real moneyâmake sure you know what you're paying.
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â ď¸ Final Reminder
This article is for educational purposes only and does not constitute investment or trading advice. Trading involves costs and risks including the potential loss of principal. Spreads vary by security and market conditions. Consult a qualified financial advisor before making investment decisions.