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Bid-offer spread
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Bid-offer spread
The bid–offer spread (also known as bid–
ask or buy–sell spread (in the case of a
market maker), and their equivalents using
slashes in place of the dashes) for securities
(such as stocks, futures contracts, options, or
currency pairs) is the difference between the
prices quoted (either by a single market
maker or in a limit order book) for an
immediate sale (offer) and an immediate
purchase (bid). The size of the bid-offer
spread in a security is one measure of the
liquidity of the market and of the size of the
transaction cost.[1] If the spread is 0 then it is
a frictionless asset.
The trader initiating the transaction is said to
demand liquidity, and the other party
(counterparty) to the transaction supplies
liquidity. Liquidity demanders place market
orders and liquidity suppliers place limit
orders. For a round trip (a purchase and sale
together) the liquidity demander pays the
spread and the liquidity supplier earns the
spread. All limit orders outstanding at a
given time (i.e., limit orders that have not
been executed) are together called the Limit
Order Book. In some markets such as
NASDAQ, dealers supply liquidity.
However, on most exchanges, such as the
Australian Securities Exchange, there are no
designated liquidity suppliers, and liquidity is
supplied by other traders. On these
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exchanges, and even on NASDAQ,
institutions and individuals can supply
liquidity by placing limit orders.
The bid–offer spread is an accepted measure
of liquidity costs in exchange traded
securities and commodities. On any
standardized exchange, two elements
comprise almost all of the transaction cost—
brokerage fees and bid-offer spreads. Under
competitive conditions, the bid-offer spread
measures the cost of making transactions
without delay. The difference in price paid
by an urgent buyer and received by an urgent
seller is the liquidity cost. Since brokerage
commissions do not vary with the time taken
to complete a transaction, differences in bidoffer spread indicate differences in the
liquidity cost.[2]
Percent spread is
.
Example: Currency spread
If the current bid price for the EUR/USD
currency pair is 1.5760 and the current offer
price is 1.5763, this means that currently you
can sell the EUR/USD at 1.5760 and buy at
1.5763. The difference between those prices
(3 pips) is the spread.
If the USD/JPY currency pair is currently
trading at 101.89/101.92, that is another way
of saying that the bid for the USD/JPY is
101.89 and the offer is 101.92. This means
that currently, holders of USD can sell 1
USD for 101.89 JPY and investors who wish
to buy dollars can do so at a cost of 101.92
JPY per 1 USD.
References
1. ^ Spreads – definition
2. ^ Demsetz, H. 1968. "The Cost of
Transacting." Quarterly Journal of
Economics 82: 33–53
doi:10.2307/1882244
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JSTOR 1882244
See also
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Bid–ask matrix
High-frequency trading
Market maker
Mid price
Scalping (trading)
Spot price
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line
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T-Model
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