Dive into the world of securities trading with a clear understanding of fundamental concepts like "bid" price, "ask" price, and the "spread." Learn how these concepts play a crucial role in market dynamics, liquidity, and the profit margins for market makers.
Key Insights
- The "bid" price is the highest price that a buyer is willing to pay for a security, while the "ask" price is the lowest price at which a seller is willing to sell a security.
- The difference between the bid and ask prices is known as the "spread."
- The bid-ask spread works in favor of the market maker and impacts the liquidity of a security - the smaller the spread, the greater the liquidity.
- Bid-ask spreads can vary widely based on the security and the market. For instance, blue-chip companies may have a spread of just a few cents, while a small-cap stock that trades less than 10,000 shares a day can have a spread of 50 cents or more.
- The bid and ask prices are determined by market dynamics, particularly the buying and selling decisions of investors. If demand exceeds supply, the bid and ask prices tend to shift upwards.
- Market makers, such as banks, profit from the spread by buying low (at the bid price) and selling high (at the ask price). For example, a bank buying 1,000,000 shares at $24.66 and selling them at $24.71 makes a profit of $50,000.
DCF Workflow
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Forecast Free Cash Flows
5-10 years of FCF based on operating assumptions.
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Calculate Terminal Value
Gordon growth or exit multiple beyond projection.
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Discount at WACC
PV each year's FCF, sum to enterprise value.
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Adjust to Equity Value
Subtract net debt, divide by shares for per-share value.
- The "bid" price refers to the highest price a buyer will pay for a security
- The "ask" price refers to the lowest price a seller will accept for a security
- The difference between these two prices is known as the spread
- The bid-ask spread works to the advantage of the market maker
- The smaller the spread, the greater the liquidity of the given security
- Bid-ask spreads can vary widely, depending on the security and the market. Blue-chip companies that constitute the Dow Jones may have a bid-ask spread of only a few cents, while a small-cap stock that trades less than 10,000 shares a day may have a bid-ask spread of 50 cents or more
- Bid and ask prices are set by the market. In particular, they are set by the actual buying and selling decisions of the people and institutions that invest in that security. If demand outstrips supply, then the bid and ask prices will gradually shift upwards
Example:
Remember, the bank will always: Buy Low / Sell High
The Bid Price (what the bank will pay to buy yours): $24.66
The Ask Price (what you will have to pay the bank to buy): $24.71
If the bank buys 1,000,000 shares at $24.66
And sells 1,000,000 shares at $24.71
Makes a profit of $50,000
Video Transcription:
Full Video Transcript
Understanding Bid and Ask Prices
When it comes to the stock markets, you often hear about bid-ask prices. Let's discuss what this means. The bid price refers to the highest price a buyer will pay for a security. The ask price refers to the lowest price a seller will accept for a security. The difference between these two prices is known as the spread.
The bid-ask spread works to the advantage of the market maker. The smaller the spread, the greater the liquidity of the given security. Bid-ask spreads can vary widely depending on the security and the market.
Spread Variations Across Securities
Blue chip companies that constitute the Dow Jones may have a bid-ask spread of only a few cents, while a small cap stock that trades less than 10,000 shares a day may have a bid-ask spread of 50 cents or more.
Bid and ask prices are set by the market. In particular, they are set by the actual buying and selling decisions of the people and institutions who invest in that security. If demand outstrips supply, then the bid and ask prices will gradually shift upwards.
Practical Example of Bid-Ask Spread
Here's an example. First of all, remember that the bank will always buy low and sell high. The bid price, the price that the bank will pay to buy your shares, is $24.66. The ask price, the price that you will have to pay to the bank to buy shares, is $24.71.
If the bank buys 1 million shares at $24.66 and sells 1 million shares at $24.71, it makes a profit of $50,000. That's the spread between bid and ask price, and the profit of the bank in our example.
