Bid–ask spread

In most financial markets there are always two prices for a particular financial instrument at any one time which are known as the bid and the ask price. The bid price is the price at which the market maker (the actual entity that is on the other side of your trade) will buy and therefore the rate at which you the client can sell. The ask price is the price at which a market maker will sell and therefore the rate at which you the client can buy.

The difference between the rate at which you can sell (the bid) and the rate at which you can buy (the ask) is referred to as “the spread”. Market makers such as the people that sit on the floor of the New York Stock Exchange in the stock market make their money from the spread, or buy charging traders more when they sell a stock than they do when they buy a stock.

Although this is changing with the advent of online trading platforms, the concept of a bid and ask price is foreign to most, because traders are most familiar with the stock market where they have traditionally called their brokers whenever they wanted to place a trade who then placed the trade on their behalf with the market maker. When they call their broker they say they would like to buy x amount of xyz stock, the stock broker simply gives the client the ask price for that stock since the client has asked to buy.

As you can see here however on this online stock trading platform, when requesting a quote for Jet Blue stock the quote window returns two prices, showing both the bid and the ask.

The stock market is in the process of going from indirect access where clients trade through a broker to get to the market maker to a more direct access environment where online trading platforms allow them to trade directly with the market maker. As the currency, forex market for individual traders really started with the internet, the market did not have to go through the same transition. Because of this most forex trading platforms show both the bid and the ask price and make their money through the spread, charging clients zero commissions to trade.

The size of the bid-ask spread from one asset to another differs mainly because of the difference in liquidity of each asset. Currency is considered the most liquid asset in the world, and the bid-ask spread in the currency market is one of the smallest, in fractions of pennies. On the other hand, less liquid assets, such as small-cap stocks, may have spreads that are equivalent to 1 to 2% of the asset’s lowest ask price.

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