Quick Answer
The bid is the highest price a buyer will pay; the ask is the lowest price a seller will accept. Buying at the market pays the ask; selling at the market receives 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 trading at the market:
- A customer buying at the market pays the ask (the higher price)
- A customer selling at the market receives the bid (the lower price)
- A market order gets the less favorable side of the quote; the spread is the cost of immediacy. A customer limit order is different: it fills only at its limit price or better, so it can execute inside the spread
- 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.
Reading a Quote's Size
A dealer's quote carries a size next to its prices: how many shares it is willing to buy at the bid and how many it is willing to sell at the ask.
- Size is shown in round lots, the normal unit of trading. For a stock priced at $250 or less, one round lot is 100 shares (higher-priced stocks carry smaller round lots).
- The first size number goes with the bid; the second goes with the ask.
- Multiply each size number by 100 to convert it to shares.
Example: A market maker quotes a stock at $20.00 bid / $20.05 ask, size 15 x 30.
- It will buy up to 15 x 100 = 1,500 shares at $20.00 (the bid)
- It will sell up to 30 x 100 = 3,000 shares at $20.05 (the ask)
A customer selling to this market maker receives $20.00 on up to 1,500 shares; a customer buying from it pays $20.05 on up to 3,000 shares.
Exam Tip: Gotchas
- Multiply the size by 100, not 10. A size of 15 means 1,500 shares, not 150.
- Each size belongs to its own price. The market maker buys the first size at the bid and sells the second size at the ask. Swapping them reverses which side buys and which side sells.
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
- A market order transacts at the less favorable price. A customer buying at the market pays the ask (higher), and one selling at the market receives 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 a customer buying at the market pays the ask and one selling at the market receives the bid?
- Do you know why the bid and ask are always two different prices?
- Can you convert a quote's size, such as 15 x 30, into shares the market maker will buy at the bid and sell at the ask?
- 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?