Buy and Sell, Bid-Ask
With an understanding of order types and who initiates trades, you can now look at the pricing mechanics of how securities are actually bought and sold.
Basic Terminology
- Buy - a customer wants to purchase a security
- Sell - a customer wants to dispose of a security
Bid and Ask Prices
Every actively traded security has two prices quoted simultaneously:
| Term | Who Sets It | Meaning |
|---|---|---|
| Bid | Buyer/dealer | "I will buy at this price" - the highest price a buyer is willing to pay |
| Ask (offer) | Seller/dealer | "I will sell at this price" - the lowest price a seller is willing to accept |
| Spread | Market forces | Ask minus bid - represents the dealer's profit opportunity and reflects market liquidity |
The key rule for customers:
- Customers buy at the ask (the higher price)
- Customers sell at the bid (the lower price)
- The customer always gets the less favorable price; the spread is the cost of immediacy
What the Spread Tells You
The spread is a direct indicator of a security's liquidity:
| Spread | Liquidity | What It Means |
|---|---|---|
| Narrow | High liquidity | Actively traded, many buyers and sellers, lower transaction cost |
| Wide | Low liquidity | Thinly traded, fewer participants, higher transaction cost |
Examples:
- A large-cap stock like Apple might have a spread of $0.01 (very narrow, very liquid)
- A small-cap stock might have a spread of $0.50 or more (wide, less liquid)
Exam Tip: Gotchas
- Customers always transact at the less favorable price. They buy at the ask (higher) and sell at the bid (lower). The spread effectively represents an immediate "cost" to the customer of entering and exiting a position.