This term refers to the difference between the highest price a buyer is prepared to pay to purchase an asset and the lowest price a seller is willing to sell an asset. Once a bidder and a seller come to an agreement about the proposed prices, they make the trade.
Bid and ask prices are established by the two leading market mechanisms known as supply and demand, and the gap between those two is what determines the bid-ask spread. Therefore, if there is a large gap between supply and demand, the bid-ask spread is large as well. That’s why the bid-ask spread is considered a measure of a security’s supply and demand, with the bid representing the demand and the ask representing the supply.
The spread also heavily depends on the market liquidity, and is usually smaller in highly liquid markets and vice versa. For instance, trading shares of the biggest companies (Apple, Tesla, Microsoft, Amazon, etc.) usually comes with a low spread.
The bid-ask spread can be expressed in both percentage and absolute terms. Here’s a simple example of a bid-ask spread calculation: if a bid price for a stock is £10 and the ask price is £12, then the bid-ask spread for that particular security would be £2.
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