What is a bid-ask spread? How it works, plus considerations for investors
Editorial Staff, J.P. Morgan Wealth Management
- A bid-ask spread is the difference between the highest price buyers are willing to pay (bid) and the lowest price sellers are willing to accept (ask). It’s both the cost to trade and a sign of a security’s liquidity.
- Spreads vary by security type and market conditions. The tighter the spread, the less you may pay, and the easier it may be to make the trade. The wider the spread, the more you may pay, and the harder it may be to place the trade.
- Frequently traded large-cap stocks and major ETFs tend to have tighter spreads, while small-cap stocks, thinly traded ETFs, options and certain bonds tend to have wider spreads.
A bid-ask spread is a critical component of trading. It is the difference between the highest price that buyers are willing to pay for a stock or other security, and the lowest price sellers are willing to accept. Ultimately, it’s the price you pay to trade, and it reflects the balance between buyer demand and seller supply.
The bid-ask spread is also an indication of market liquidity, or the ease with which a security trades in the market. The spread can change based on the security type and market conditions, which is why it's important for investors to understand how the bid-ask spread works. Here’s what you need to know.
Bid vs. ask: How buyers and sellers set prices in the market
When it comes to setting market prices, buyers and sellers drive movement through the bid and ask prices. The bid is the highest amount someone is willing to pay at the current moment for one share of a stock or other security, and the ask is the price someone is willing to sell it for. The difference between those two numbers (the ask minus the bid) equals the spread.
For example, let’s say a stock has a bid of $25 and an ask of $25.02. The spread is just 2 cents. This means you can buy the stock for $25.02, keeping your transaction cost to just 2 cents per share. In contrast, a stock with a $25 bid and a $26 ask has a spread of $1.
The spread can also be measured in percentage terms to show how much of your trade value goes toward that gap. To do this, investors often look at the midpoint, or the middle price between the bid and the ask. It can be calculated by adding the ask price to the bid price and dividing by two.
Oftentimes, investors think in terms of “mid” because it gives them a fair value price for the security at the center of the spread. Dividing the spread by the midpoint tells you the true percentage cost of the trade. That’s calculated by subtracting the bid from the ask and dividing by the midpoint.
For instance, a $1 spread on a stock with a $25.50 midpoint costs 3.9% of your money. That same $1 spread on a stock with a $100 midpoint costs 1%. Looking at the percentage spread makes it easy to compare real trading costs across stocks at different price points.
Competing interests at play
At the core of the bid-ask spread are competing interests: buyers who want to pay the lowest price possible and sellers who want to make as much money as they can. The bid represents the standing demand – or the price buyers are gearing up to pay – while the ask represents the standing supply – or the price sellers will take. The trade occurs when both parties agree to accept the terms.
These transactions don’t occur on an individual basis, however. Instead, they are made through an order book, which is an electronic, real-time list of all the open buy and sell orders for a security organized by price. It’s managed by the stock exchanges and accessible to market makers, institutional investors and retail traders.
Within the order book, multiple bid and ask orders exist at different prices and sizes. The top of the book – representing the best bid and best ask – is where most trading occurs. The best bid is the highest price a buyer is offering, and the best ask is the lowest price a seller is accepting. Price changes, driven by regular investors and market makers, can happen at any moment as orders are placed, canceled or executed. Market makers facilitate trading by constantly posting bids and asks, earning a portion of the spread for taking on the risk of holding shares.
Get up to $1,000
When you open a J.P. Morgan Self-Directed Investing account, you get a trading experience that puts you in control and up to $1,000 in cash bonus.
Why the spread matters: How it impacts what you pay (or receive)
The bid-ask spread has a direct impact on how much you pay for a trade by acting as an implicit cost in the following ways:
- You instantly lose money: If you buy at the ask price and immediately sell at the bid price, you lose the amount of the spread, assuming there were no underlying market price changes or fees.
- It can erode returns: High-frequency trading in assets with wide spreads may hurt your profits over time, potentially derailing your long-term goals, such as saving for retirement.
- Costs may compound: Executing large orders in illiquid securities with wide spreads could compound your total execution costs if the price moves against you.
Remember, the spread is different from other trading costs. The spread is a structural cost that is part of the market, whereas commissions, regulatory fees and taxes are explicit expenses. Consider all costs before trading stocks or other investments, and work with a financial professional if you need help.
What determines how wide or tight a spread is?
Several factors determine how wide or tight the spread is for a particular security. Understanding them can help you decide whether an investment is too risky or if it may fit well in your portfolio:
- Liquidity and trading volume: The more actively traded the security, the tighter the spread, since it’s easier for the asset to change hands.
- Volatility and uncertainty: Rapid price swings may lead to wider spreads. This is because market makers face higher risk holding inventory and widen the gap to protect themselves.
- Time of day: The spread on a security is typically wider at the open and close of the trading day because of higher price volatility and unpredictable order flow. The spread tends to be tighter midday as trading stabilizes and volume gets more predictable. Keep in mind there are always exceptions.
- News and events: The spread may tighten or widen based on the news surrounding a company, whether that’s an earnings report, an economic release or a breaking news headline.
- Security structure: Stocks and ETFs have a bid-ask spread, and those with a lot of volume, high liquidity and large market caps tend to have tight spreads. Stocks and ETFs that are thinly traded, small-cap and/or specialized tend to have wider spreads. Mutual funds do not have a bid-ask spread. Instead, they trade once a day at their end-of-day net asset value (NAV). Bonds and many fixed-income instruments tend to have wider spreads because they trade over the counter with lower liquidity and less price transparency. Meanwhile, options spreads may vary depending on when the contract is set to expire or where the strike price sits relative to the stock's current price. For instance, at-the-money or near-term options often come with tighter spreads, while far out-of-the-money or long-term options have wider spreads.
- Market conditions: How the market is performing overall can have a direct impact on bid-ask spreads. If stocks are soaring and the market looks positive, spreads can be tight. But if the economy is tanking and uncertainty looms, spreads across the board could be wider.
Practical tips to potentially minimize spread costs
You can’t avoid the bid-ask spread completely, but there are steps you can take to lower your exposure.
Limit orders, which are instructions to buy or sell a security at a specific price or better, are a common tool. They help prevent you from paying a wider-than-expected spread when the market is moving fast.
You can also trade high-volume stocks, execute trades during peak liquidity hours, and be cautious around breaking news and announcements (such as earnings). Be mindful when trading smaller, illiquid stocks and niche ETFs that the spread will likely be wider, and consider breaking up larger trades to avoid forcing the price against you in illiquid markets.
It's also important to check the spread before you trade. You can do so by using the percentage spread to compare true transaction costs across securities at different price points. Remember that’s calculated by dividing the spread by the midpoint price: (ask – bid) / midpoint.
The bottom line
The bid-ask spread is the difference between a security’s buy and sell prices. It’s also a measure of how liquid and actively traded a security is. Timing, popularity and liquidity can have a real impact when it comes to bid-ask spreads. A large-cap stock that investors are clamoring to own, for example, will likely have a tighter spread than a small-cap stock nobody has heard of.
Before you buy shares of any asset, check the spread, consider limit orders when appropriate and understand the costs of the trade. Being aware of how bid-ask spreads work can help you be more intentional about your investments and executions.
Frequently asked questions about bid-ask spreads
No. The bid-ask spread is an implicit, structural part of trading. It is the difference between the price buyers are willing to pay for a security and the price sellers are willing to accept. The commission or trading fee is set by brokers and is an explicit cost of trading.
The bid-ask spread is typically wider for stocks and ETFs that are less popular and that have smaller market caps, lower volume and higher volatility. Market makers face higher risk holding these shares in inventory because they take longer to sell. Market makers widen the spread to compensate for that risk and to protect against sudden price swings.
Yes. The bid-ask spread tends to be wider at the open and close when volume is high and prices are volatile. Things settle down by midday when the spread tends to tighten. Keep in mind, however, that these are not rules and spreads can vary.
Invest your way
Not working with us yet? Find a J.P. Morgan Advisor or explore ways to invest online.
