Day Trading Basics: The Bid Ask Spread Explained
If you’re beginning your trading journey, you may be unaware that a stock (forex pair, futures contract or option) actually has two prices at all times, and not just one. The two price are called the Bid and the Ask, and understanding the “bid ask spread” is crucial if you want to get into day trading.
The Bid and Ask Price
If you view a stock quote on a website, you’ll often see only one “current” price listed. This is the price where the “Last” transaction took place; if you went to buy or sell that stock there’s a good chance you won’t get that same price.
Even if the stock doesn’t move between the time you get the quote and place your trade, you many not get that “last” price. The reason is that there are two prices for every stock, forex pair, option, and futures contract. There’s the price buyers are willing to buy at, called the “Bid,” and there’s the price sellers are willing to sell at, called the “Offer” or “Ask”.
Buying and Selling at the Bid and Ask Price
If you want to buy a stock you can place an order at the Bid price and hope that someone will sell to you, or you can place an order to buy at the Ask price. A person who wants to sell would do the opposite, placing an order to sell at the Ask price or selling to the people who are waiting to buy at the Bid price.
The Bid is always lower than Ask price, which means if you buy at the bid you’ll be getting a better price than if you buy from someone selling at the offer price (only at that moment, since prices constantly fluctuate). Likewise, a person selling will get slightly more (higher price) if they sell it at the Ask price as opposed to selling it to someone who’s bidding.
If you’re bidding to get into a position, someone needs to sell you their shares. Putting out a Bid or Offer doesn’t mean you’ll actually get the shares. If you place a Bid or Offer and receive the shares, then your order is considered “filled” and your account will show you either just bought or sold shares (or other asset).
The Bid Ask Spread
The difference in price between the Bid and Ask is called the Bid Ask Spread. It can be large or small, and depends on factors such as the price of shares, and mostly volume (how many shares change hands each day). Very high priced stocks typically have a larger spread, and with low volume it can widen even more. A Bid for example may be $563.28, while the Ask price is $563.91 for a stock; that’s a $0.63 Bid Ask Spread. A lower priced stock, with lots of buyers and sellers participating in it, will have a 0.01 spread most of the time. The Bid Ask Spread can fluctuate as the price moves (and is how the price moves) and the posted Bids and Offers are filled by other traders.
The highest Bid and the lowest Offer are displayed as the current price in trading platforms. Other bids which are below the current price, and other offers which are above the current price show up in a “Level II” screen (like the one shown to left). The Level II shows multiple levels of buyers and sellers Bidding and Offering, and how much (shares, lots, contracts) they’re bidding and offering. Figure 1 shows Bids and Offers using the CBOE Equities exchange in Home Depot (HD) stock. You can see the number of shares being bid/offered, as well as the price. The current Bid Ask Spread is 90.21/90.22, or $0.01.
Figure 2 shows a Level II screen for forex trading, courtesy of FXopen. This plugin allows for easy forex trading as you can set your position size at the top, see the current Bid Ask Spread (difference between highest bid price and lowest offer price), see the current Bids and Offers, and set your order price/stop loss/target near the bottom of the plugin.
Most company stocks, that are household names, trade with a small Bid Ask Spread of (usually) one cent if the stock is priced below $100. Heavily traded forex pairs will typically have a Bid Ask Spread of 2 pips or less with most brokers. In figure 2 the spread is less than half a pip.
Take Advantage of the Bid Ask Spread
When possible, and depending on the day trading strategy being employed, it’s ideal to get the best price possible. If it’s likely you’ll get filled on the Bid side, because the price is dropping, then it is best to buy at that lower price (the Bid) instead of unnecessarily paying the higher Ask price. Buying at the Ask price (or selling at the Bid price) is called “paying the spread.” If you do it on every trade, the amount it takes out of your profits can become significant. Be frugal and try to get the best price whenever possible.
That isn’t always the best option though. In fast-moving markets, where you need to get into or out of a position quickly you’ll likely need to “pay the spread” (buy at the offer or sell at the bid), because if you don’t you likely won’t get into or out of your position. Most forex brokers, although not all, require that you pay the spread when entering and exiting a position. It’s for this reason forex day traders seek forex brokers with low spreads (low bid ask spread). Think of the Bid Ask Spread as a hidden trading cost. It can work against if you always have to pay it, but it can work for you–in the way of slightly increases profits–if you pick your entry points carefully.
By Cory Mitchell, CMT
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