Bid and Ask Price Explained

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Bid and Ask Price Explained

When trading, you will hear about the “bid and ask price.”

What is it, and how do you use it?

What is the Bid and Ask Price?


Very easy: 
– The “Bid” is the price that buyers are willing to pay for a stock and
– The “Ask” is the price that sellers are willing to sell a stock for.

Here’s an example:

Bid and Ask Price - Example 1

In this example, buyers are willing to pay $259.06 for Apple (AAPL), but sellers want at least $259.10 per share.

Let’s think about it for a moment:

Some people think that the exchange is determining the price of a stock.

And that’s not the case!

The price of a stock is determined by the price that buyers and sellers are willing to trade at.

Let me give you an example:

When you walk into an art gallery and see a painting with a price tag of $30,000, then THIS is the asking price of the seller of the painting. 

It’s NOT the “fair price.”

It’s simply a price that the seller would like to get when selling the painting.

He’s “asking” for it.

You, as a potential buyer, could now offer – or bid –  $20,000.

Now the seller has 2 choices:

  • He can accept your bid or
  • He can lower his asking price and see if you’re willing to buy the painting at a lower price.

As you can see, the final “trade price” is determined by the price that the buyer and seller agree on.

Same with stocks: 

The “last price” of a stock is the price that buyers and sellers agreed on.

That’s the price a trade was made.

However, you can not buy a stock at the last price traded.

If you want to buy a stock, you have to find a seller who’s willing to sell to you. 

Why Is The Bid And Ask Price So Different?

Sometimes you will see that the bid and ask price is very different.

Here’s an example:

Bid and Ask Price - Example 2

In this example, buyers are willing to pay $20.80 (BID) for this stock, but sellers want at least $21.50 (ASK).

The difference between the bid and ask price is called “the spread,” and in this example, the spread is $0.60. 

In the previous example with Apple stock, the “bid/ask spread” was only $0.04.

So why is the bid and ask price for this stock so different?

A large bid and ask spread is usually caused by one of the following 2 conditions:

  • You’re looking at a stock with low trading volume, i.e. there are simply not many buyers and sellers or
  • You’re 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 5 min before the open.

Shortly after the open, the bid/ask spread was much smaller:

Bid and Ask Price - Example 3

As you can see, the bid/ask spread tightened from $0.60 to only $0.04.

The next question is…

What Happens When Bid And Ask Are Far Apart?

Well, at some point either the buyers or the sellers need to make another offer.

Either the buyers need to raise their bid, or the sellers have to lower their ask.

Otherwise, no trade would take place.

It’s like in our art gallery example from earlier:

If the seller keeps insisting on a price of $30,000 and not a cent below, and the buyer is only willing or able to pay $20,000 and not a cent more, then the painting won’t be sold.

Same in the markets:

Only if the buyers and sellers agree on a price, a trade can take place.

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What Is a Normal Bid/Ask Spread?

When trading stocks, a “normal” bid/ask spread is usually $0.01 – $0.04.

Whenever you see a larger bid/ask spread, you are either looking at a stock that’s not very liquid, or you’re looking at the stock outside of regular trading hours.

For options, a “normal”  bid/ask spread is $0.05 – $0.20 for 2 reasons:

  1. Most options are trading in $0.05 increments, i.e. $1.10, $1.15, $1.20 etc.
  1. Options are not as liquid as stocks. Only a fraction of traders are trading options, therefore, there are fewer buyers and sellers.

Should I Buy At The Bid Or Ask Price?

Let’s review:

The BID is the price that buyers are willing to pay for a stock, and it’s usually lower than the ASK.

It would be GREAT if we could buy at the bid price, but most of the time, that’s not possible.

We can either buy a stock at the ask price, or we can make an offer that’s between the current bid and ask and see if one of the sellers is willing to take the trade.

Here’s an example:

Bid and Ask Price - Example 4

Buyers are willing to pay a maximum of $8.30 for this stock, but sellers want $8.73.

If you wanted to buy the stock, you could offer $8.40 and see if a seller is willing to sell you the stock at that price.

Often traders split the difference and offer a price in the middle, a.k.a. the “mid” price.

This brings us to the next question:

Can You Buy Stock For Less Than The Ask Price?

Absolutely!

When you step out of the pool of buyers and offer a higher price than everybody else, you might find a seller who’s willing to take your bid.

In the example above, the bid is $8.30 and the ask is $8.73.

So the “mid-price” would be $8.52.

If you would raise your bid to $8.50 or $8.55, which is close to the mid-price, it is very likely that there’s a seller who is willing to take your bid.

It’s VERY important that you know what order to use if you try to bait sellers.

Fortunately, I have an article for you that explains “The Difference Between A Stop Order And A Limit Order.”

In a nutshell, if you want to buy a stock for less than the asking price, you should use a limit order

Read the article to learn more about it.

Now you know what the bid and ask price is and how to use it in your trading.

By the way, if you would like to know how I personally trade, you can see my full trading plan here: MyTradingRoutine.com

Enjoy!


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