What are bid and ask prices in trading?

As we mentioned earlier, the bid prices refer to the price investors, brokers, or institutions are willing to pay for a financial asset, and the asking price refers to the price investors, brokers, or institutions are willing to sell the financial asset for.

Now, we know that the bid price refers to the price investors, brokers, or institutions are willing to pay for a financial asset; what this means for you as a retail trader is if you want to open a sell position, you’ll look at the bid price. 

Meanwhile, if you are looking to open a buy position on a financial asset, you’d look at the asking price because this is the price investors, brokers, or institutions are willing to sell at.

You’ll find that the asking price is always higher than the bid price; the reason for this is due to the spread. We’ll explain the spread and its significance in more detail later in this article.

There might be cases where the bid and ask prices are the same. However, this is very rare because the spread is always present. If this does occur, it will be rectified quickly to keep up with the relevant market prices for that financial asset you might be trading.

Now that you have a better understanding of the bid and ask prices let’s look at an example to put this into perspective.

Let’s say you’re looking to trade Facebook shares. You see that Facebook has an asking price of $100.02 and a bid price of $100; the $0.02 is the spread. 

If you were to open a buy position, you’d look at the asking price of $100.02; if you were to open a sell position, you’d look at the bid price of $100.

Now, suppose you decide to open a buy position of 10 shares of Facebook stock at an asking price of $100.02; this will give you a total of $1000.20.

If you decide you’d rather sell ten shares of Facebook stock at a bid price of $100, this will give you a total of $1000.

In this example, the $0.20 would go to the trading broker as payment for executing the trade on your behalf.

As previously mentioned, the difference between the bid and ask prices is known as the spread. 

The spread represents the cost that goes towards the broker in order to execute a trade on your behalf; at the same time, it’s also the broker’s compensation.

There are two different types of spreads available in trading: fixed spreads and variable spreads. Fixed spreads mean the spread will stay the same during bid and ask price fluctuations. Whereas variable spreads change with the fluctuation of the bid and ask prices.

The spread also indicates liquidity, which is truer when trading with variable spreads. 

Liquidity works in the following way: If a financial asset has a high level of liquidity, it means a large number of market participants are willing to buy or sell that particular asset. Whereas if the liquidity level is low, there aren’t many market participants for a specific financial asset.

Now, the way liquidity impacts the spread is as follows: if a financial asset has a high level of liquidity, the spread will generally be smaller, whereas if a financial asset has a low level of liquidity, the spread will usually be wider.

The reason why the spread becomes wider with a lower level of liquidity is because it becomes more difficult to buy or sell a financial asset due to a lack of trading volume.

The bid and ask prices are determined by the market. Specifically, they are determined by the buying and selling decisions of traders, investors, and institutions.

This translates to supply and demand.

If the demand for a financial asset increases, the bid and ask prices will also gradually increase. Meanwhile, if the supply of a financial asset increases, it will cause the bid and ask prices to decrease gradually.