What is a bid?
A bid, short for bid price, refers to the maximum price a potential buyer is willing to pay for a financial instrument, as well as the quantity of the financial instrument the buyer will purchase.
A bid represents the demand side of a security.
To complete a trade transaction, another price is needed – the ask price, also referred to as the offer price.
What is the ask price?
The ask price, commonly known as the ask, is the lowest price a seller will accept for a financial instrument.
The ask price represents the supply side of security.
The bid-ask spread
The difference between the bid price and ask price is called the bid-ask spread, which is the cost that a trader will incur when he or she opens a trading position.
In financial markets, the ask and bid prices are shown in real-time and are continuously updating. The changing difference between the bid and offer price is an important indicator of the liquidity of a financial market and the amount of the transaction cost.
Typically, the bid-ask spread narrows the more liquid a market is. Contrariwise, when a market lacks liquidity the spread widens. Put differently, the closer the bid price comes to the ask price, the more valuable the security is and therefore has more liquidity as it can be quickly sold if required.
In short, liquidity refers to the ease and speed at which a financial instrument can be sold.
Bid-ask spreads can vary significantly, depending on the particular security and financial market. For example, blue-chip companies may have a spread of only a few cents, while companies with small market caps may have quite wide spreads.
In addition, the bid-ask spread can widen drastically during times of illiquidity or market turmoil, when potential buyers are not prepared to buy above a specific threshold. Conversely, sellers may not accept prices below a certain level.
Market makers, also known as liquidity providers, play an important role in financial markets, providing liquidity to markets by mediating between buyers and sellers and being ready and able to buy and sell financial instruments at any time during trading hours.
Market makers generate profits from the bid-ask spread.
The bid price in relation to the current price of a financial instrument
A trade or transaction is clinched when the buyer and the seller agree on a price for the particular financial instrument.
The agreed-upon price is called the current price, also referred to as the market value. The bid price will always be lower than the current (market) price, while the ask price will always be somewhat above it.
Naturally, trading comprises numerous buyers and sellers, constantly bidding and offering prices with regard to a particular financial instrument or asset. Therefore, the current price is continuously fluctuating and is determined by the latest trading price of the asset.
Put differently, the current price is determined where supply and demand meet. The rise and fall of the current market price are respectively caused by fluctuations in the demand for and supply of a particular financial instrument.
The bid and ask in forex trading
In forex trading, the bid price is the price a trader is willing to sell a base currency for, which is the first listed currency of a currency pair. The ask price is the price at which a forex trader is willing to buy a currency pair, as reflected in the second currency, referred to as the quote currency, in a currency pair. The second currency is also called the counter currency.
As with other financial instruments such as shares, the bid and ask prices in forex trading are indicated in real-time and are constantly updating.
For example, let us say we have the following quote of the EUR/USD currency pair: 1.1995/1.2000.
In the quote above, 1.1995 is the base currency, which indicates the bid price, while the quote currency of 1.2000 reflects the ask price.
The bid price is quoted as lower than the ask price, and the difference between the two prices is called the spread, short for bid-ask spread. In the example above the spread is 5 pips (1.2000 – 1.1995).
Important to know about bid prices
A bid price will often vary depending on the objective of the buyer. For instance, a long-term investor would more easily pay the asking price of R50 per share of a company than a trader who is looking for an opportunity to make a profit. The profit-seeking trader would look to purchase the shares at a bid price of R48 per share in order to sell them at R50 per share, gaining a profit of R2 per share.
Normally, traders want to get a better price. Hence, instead of accepting the current bid or ask price, they may try to buy a little lower or sell a bit higher. However, when a trader is under pressure to buy, he or she will buy at any price they can get.
Important to know, a bid price is only valid for the number of units of a security specified in the bid price. If you bid R70 000 (R1 000 per share) for 1 000 shares of company TSG, it does not mean that 1 500 shares will also cost you R1 000 per share. This is because the price of a security is constantly changing.
Concerning the law of supply and demand, when the bid volume is more than the ask volume, the selling is stronger, and the bid price is more likely to move down than up. Contrarily, when the ask volume exceeds the bid volume, the buying is stronger, and the bid price is expected to rise.
Potential buyers have a choice of options regarding the placing of orders, namely:
- A buy limit order
Is an order from a trader to a broker to buy a security at a predetermined price (the limit price) or a better price. The order will only be executed at the limit price or a lower price.
- A market order
A market order is a buy (or sell) order in which a trader requests a broker to execute the order at the best price currently available in the market. Usually, this type of order is used when a trader is convinced of a security’s price, or when a trader is compelled to exit a position quickly.
However, the order is subjected to the availability of the particular security.
Note: This article does not intend to provide investment or trading advice. Its aim is solely informative.
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