Quick Answer
The bid is the highest price a buyer will pay; the ask is the lowest price a seller will accept. Customers always buy at the ask and sell at the bid, the less favorable price in each case. A narrow spread signals high liquidity; a wide spread signals low liquidity and higher transaction cost.
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
- The bid and ask are always two different prices: the ask is always higher than the bid. A quote of $48.50 bid / $49.00 ask means a buyer pays $49.00 while a seller receives only $48.50. They are never the same dollar amount.
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.
What Should You Check on Exam Day?
- Can you explain why customers buy at the ask and sell at the bid?
- Do you know why the bid and ask are always two different prices?
- Can you explain what a narrow spread versus a wide spread tells you about liquidity?
- Do you know which price, bid or ask, is more favorable to the customer?