Bid and Ask Price Explained – Here’s What You Need To Know

   

The Bid and Ask Price are two things you’ll hear quite often when trading stocks. 

In this article, I want to review what exactly the Bid and Ask Prices are, and how you should use it when trading. 

Let’s get started!

What Is The Bid and Ask Price?

I find the easiest way to think of the Bid and Ask Prices are as follows:

The Bid is the price that buyers are willing to pay for a stock.

The Ask is the price that sellers are willing to sell a stock for.  

Here is an example using AAPL Stock:

Bid and Ask Price - Example 1

In the image above, which is an older one as you can probably tell, buyers are willing to pay $259.06 for AAPL stock, but sellers want at least $259.10 per share. 

Let’s just think about that for a minute:

A lot of investors think it is the brokerage or market makers determining the price of each stock. 

That’s actually not the case! 

The price of the stock is determined by the price that buyers and sellers are willing to trade the stock at. It’s all just simple supply and demand!

Looking At The Bid/Ask Price In Real Life

Here’s a real-life example to illustrate what I mean by this:

When you walk into an art gallery and you see a piece of art, maybe a painting, that you think looks really nice your first instinct is to check the price tag. 

If the painting has a price tag of $30,000, this is the asking price of the seller of the painting, not necessarily the ‘fair price.’ 

This is the price that the owner or artist is ‘ASKing’ for. See what I did there?

Now you as a potential buyer could now offer or BID the price of $20,000. 

At this point, the seller has two choices:

  1. They can accept your bid price or
  2. They can lower the asking price to see if you’re willing to buy the painting at a lower price than what was asked for, but higher than your bid.

As with stocks, the final ‘traded price’ is determined by the price that the buyer and seller agree upon. 

The price that the shares sell for is the price that the buyer and seller agreed on to make the trade. 

Once this trade is completed that ask price no longer exists. You must buy more shares at a price that another seller is asking for. 

Why Is The Bid And Ask Price So Different?

A lot of investors wonder why the Bid and Ask price are so different. 

Here’s an example:

We can see the difference between the Bid and Ask price for MLCO is much larger than in the previous example with AAPL. This can be confusing for new traders.

For MLCO on this date, the Bid price was $20.80 but the sellers wanted at least $21.40. 

The difference between the Bid price and the Ask price is called the Spread. 

In the example for MLCO, the Spread is $0.60 but in the previous example for AAPL, the Spread was only $0.04. 

Why is there such a large disparity in the Spread for each stock?

A large Bid and Ask spread is usually caused by one of the following two conditions:

  • The stock in question has a low trading volume, i.e. there are simply not many buyers and sellers or
  • You might be looking at the stock during “after hours”, i.e. outside regular trading hours. 

If that’s the case, then you will see the Bid/Ask spread tighten immediately after the open. 

In the example above, I took the screenshot for MLCO’s spread five minutes before the opening.

Shortly after the markets opened for the session, the Bid/Ask spread was much smaller:

Bid and Ask Price - Example 3

As you can see, the Bid/Ask spread for MLCO tightened from $0.60 to only $0.04.

That begs the question:

What Happens When The Bid And Ask Are Far Apart?

At some point, either the buyer or the seller needs to make another offer for the trade. 

This means that the buyers need to raise their Bid price or the sellers need to lower the Ask price. Unless they can meet in the middle, the trade won’t happen!

Think back to the art gallery from earlier. If the seller insists that they want $30,000 but you are only willing to pay $20,000, then the deal is not going to happen. 

The same goes for stocks: if the buyers and sellers can’t agree on a price, then the trade is not going to take place. 

What Is a Normal Bid/Ask Spread?

In stock trading, a ‘normal’ Bid/Ask Spread is between $0.01-$0.04. If you happen to see a larger Bid/Ask Spread, think back to the two reasons we talked about earlier: a non-liquid stock or you are trading before or after normal trading hours. 

When it comes to options trading, the normal Bid/Ask Spread is between $0.05-$0.20. There are a couple of reasons for this:

  1. Most options contracts trade in $0.05 increments. For example contracts for $1.10, $1.15, $1.20, and etc.
  2. Options are also not as liquid as regular stocks. Only a small number of traders are even involved in options trading so there are inherently fewer buyers and sellers. 

Should I Buy At The Bid Or Ask Price?

To get a better idea of how to answer this question, let’s do a bit of a review:

The Bid is the price that a buyer is willing to pay for the stock. This price is almost always lower than the Ask.

The Ask is the price the seller is willing to sell the stock for. 

In a perfect world, we would be able to buy the stock at the Bid price, but that’s rarely possible. 

So our two options as buyers are:

  1. To simply pay the Ask price of the seller or
  2. To make a new Bid price that is usually higher than your original.

Here’s an example:

Bid and Ask Price - Example 4

So we can see that buyers are willing to pay $8.30 and sellers want $8.73 for this stock.

If you wanted to buy the stock, you could make an offer of $8.40 and see if the seller is willing to meet you at that price. 

This is the most frequent result of a trade: the buyer and the seller meet in the middle at a Mid-price. 

So that leaves us with one last question left to answer:

Can You Buy Stock For Less Than The Ask Price?

Absolutely! 

When you are bidding on something, we know that the highest price usually wins. If you can offer a higher Bid price than the other buyers, it’s easier to find a seller that will accept your offer.

In the NNBR example above, the Bid price is $8.30 and the Ask price is $8.73. The absolute Mid-price would be $8.52. 

If you raised your Bid price to $8.50 or even $8.55, there’s a pretty good chance a seller will accept your Bid. 

Before you enter that order, make sure you know exactly what type of order to make. Check this article out that explains “The Difference Between A Stop Order And A Limit Order.” 

In a nutshell, if you wish to buy the stock for less than the Ask price, you should use a Limit Order. But please do read the article to learn more about it and for a full explanation. 

So now you know what the Bid and Ask prices are, and how you can use them to your advantage when trading. You also know what the Spread and Mid-prices are now too!

By the way, if you’re looking to know exactly how I trade, then go see my full trading plan here: MyTradingRoutine.com.

Enjoy!

Read Next: Generating SRC Profits



Related Posts

Day Orders Vs Good Till Canceled Orders – What’s The Difference?

Day Orders Vs Good Till Canceled Orders – What’s The Difference?

I’m BACK!

I’m BACK!

Open P&L (Profit & Loss): What Is It And Why Do You Need It?

Open P&L (Profit & Loss): What Is It And Why Do You Need It?

I got caught breaking the law – ON CAMERA! 😲 

I got caught breaking the law – ON CAMERA! 😲 

Leave a Reply


Your email address will not be published. Required fields are marked

{"email":"Email address invalid","url":"Website address invalid","required":"Required field missing"}