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What is the Bid-Ask Spread?
![Author: Tahir Ismail](/data/uploads/0000308000/000/abi_0000308018.thumb.100.jpg)
Posted: Jul 22, 2020
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Whether you're new to investing or have been trading in the stock market for years but want to expand your knowledge, it may be time to learn about the bid-ask spread. Paying attention to a stock's bid-ask spread can help you make purchases and trades that benefit your portfolio. Learn more about what a bid-ask spread is and how to choose the right order type.
What Is the Bid-Ask Spread?
The first part of understanding the bid-ask spread is to have a knowledge of both bid and ask. Here are the basic definitions:
- Bid: A bid is the most that a buyer will pay for stocks and other investments.
- Ask: An ask is the minimum price for which a seller will sell their stocks or securities.
The bid-ask spread is the difference between the bid and the ask, and it's important to know so you can trade when it's best for your portfolio. The bid-ask spread can be large or small, but no matter the size, the spread makes a difference in the final selling price of a stock. Once a buyer purchases a stock at the ask price, that stock falls in value to the bid price. Using this information, a buyer may strategize to perform quick trades that will allow them to purchase more stocks for less money.
Example of the Bid-Ask Spread
The basic bid-ask spread is a simple calculation: Subtract the bid price from the ask price. For example, if Corporation XYZ wants to sell each stock unit for $10, and buyers are bidding at $8, the bid-ask spread would be $2, or the difference between the bid and the ask. If a buyer purchases the stock at $10, the stock's value drops to $8, or the bid price, so that any buyer who purchases a stock and then sells it would be selling it for a $2 loss per unit.
Types of Orders
There are five orders to choose from:
- Market Order: A request to buy or sell a stock at the current market value.
- Day Order: An order that is only valid for that day's trades.
- Limit Order: An order to buy or sell a security at a certain price or better.
- Fill or Kill: A transaction that must happen immediately or it'll be canceled.
- Stop Order: An order to buy or sell a stock once a certain price is reached.
Market, limit, and stop orders are the most common.
Choosing the Right Order Type
There isn't a set rule to follow when choosing an order type. Given the three most popular order types, here are some considerations to make:
- Think about choosing a market order when you think a stock is priced appropriately and you want to complete a transaction immediately.
- Consider a limit order when you're set on what you want the stock price to be before making a move.
- Choose a stop order when you want to buy or sell at a specific price. Once the price reaches your stop limit, it turns into a market order and the transaction is immediate.
Investing in the stock market definitely has its benefits. As long as you invest when the time is right, you can experience long-term success.
About the Author
Tahirnajmi is an evergreen investor that creates, grows, and funds innovative companies and talented entrepreneurs in the St. Louis region.
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