Bid-ask spread is a central element of trade execution. It is the small gap between the highest price buyers are willing to pay and the lowest price sellers are willing to accept at a given moment. Although it looks simple on a quote screen, the spread reflects how liquidity is supplied, how orders are prioritized, and how risk is transferred in modern markets. Understanding it helps clarify why the price you receive often differs from the last trade and why identical orders can produce different results at different times of day.
What Are the Bid, the Ask, and the Spread
The bid is the highest price currently offered by buyers for a security. The ask (also called the offer) is the lowest price at which sellers are currently willing to sell. The bid-ask spread is the ask price minus the bid price. If a stock shows a bid of 50.00 and an ask of 50.02, the spread is 0.02.
This gap is not an error or delay in pricing. It is the explicit price of immediacy. Traders who demand immediate execution by placing marketable orders cross that gap and trade at the standing quote. Traders who supply liquidity by posting limit orders on the bid or ask help define that gap and may earn the spread if their orders are executed.
Why the Bid-Ask Spread Exists
Spreads exist for economic and microstructural reasons:
- Compensation for liquidity provision: Liquidity providers commit capital to stand ready to buy from sellers and sell to buyers. The spread compensates them for inventory risk and the cost of keeping orders in the book.
- Inventory and holding risk: Quotes can be hit by informed order flow. If a market maker buys at the bid and the price falls, they bear a loss. A spread offsets the average expected risk of adverse price moves.
- Transaction costs and infrastructure: Technology, exchange fees, and regulatory obligations entail costs. Spreads help cover those costs, along with any exchange or broker fees the liquidity provider pays.
- Information asymmetry: Some orders may reflect superior information. To offset the risk of trading against better-informed counterparties, liquidity providers widen quotes when uncertainty rises.
- Tick size constraints: Minimum price increments limit how finely quotes can undercut one another. A one-cent tick can keep the spread at one cent even if competition would otherwise compress it further.
How Quotes Are Built: The Order Book
Most modern markets use electronic limit order books. Participants submit limit orders to buy or sell at specific prices. The book sorts these orders by price and then by time. The highest remaining buy price becomes the best bid. The lowest remaining sell price becomes the best ask. Together they form the national best bid and offer in markets like US equities, or the best available quote on a given venue in other asset classes.
Marketable orders interact with this book. A market order to buy immediately executes against the best ask. A market order to sell executes against the best bid. If the order size exceeds the available quantity at that price, it sweeps to the next levels in the book, potentially increasing the realized cost.
Liquidity is not only about price. Depth matters. A one-cent spread with only 100 shares available may be less accommodating for larger orders than a two-cent spread with thousands of shares at the top of book. Traders often inspect depth through Level 2 or full book displays to anticipate how much of their order will fill at each price level.
What the Spread Means for Execution
The spread represents a direct, visible component of trading cost. When you buy at the ask and then turn around and sell at the bid, you crystallize the spread as a loss, ignoring any interim price move. The impact depends on price level and spread size. A 2-cent spread on a 50-dollar stock is 0.04 percent. A 20-cent spread on a 5-dollar stock is 4 percent. The same absolute spread can be negligible in one context and material in another.
Market Orders and the Spread
Market orders prioritize immediacy. They accept the best available price and are more likely to cross the spread. Buying at the ask usually means paying the spread relative to the mid price, which is the average of bid and ask. Selling at the bid means conceding the spread to the liquidity providers on the other side.
Volatile periods can widen spreads as liquidity providers step back or adjust quotes. In such moments, the cost of crossing the spread increases. Large market orders that exceed top-of-book quantities can also incur additional cost by executing across multiple price levels in the book.
Limit Orders and the Spread
Limit orders can either join the bid or ask, or rest inside the spread. A buy limit placed at the current bid contributes liquidity at that price. A buy limit placed at the midpoint or slightly below the ask narrows the spread if matching rules and tick size allow. If an opposing order arrives, the trade may execute at a price better than the standing ask, a form of price improvement.
Queue position matters. When multiple orders are posted at the same price, time priority determines which fills first. Entering earlier in the queue increases the chance of getting hit or lifted as the market streams through that price.
Stop and Stop-Limit Orders
A stop order converts into a market order once the trigger price is reached. A buy stop that triggers in a fast tape may execute at the ask or higher if the quote moves quickly. A sell stop may execute at the bid or lower under similar conditions. The spread therefore influences where stop orders are filled, especially when quotes gap or widen during stress.
Partial Fills and Book Depth
When order size is larger than the liquidity available at the top quote, partial fills can occur. The remainder executes at the next available price levels. The effective cost can exceed the quoted spread because the order consumed depth at multiple prices. This outcome depends on both spread and depth, and it explains why top-of-book quotes, although useful, do not tell the entire execution story.
Measuring the Spread in Practice
Practitioners evaluate spreads in several related ways:
- Quoted spread: The prevailing ask minus bid at a point in time. Easy to observe, but it may change quickly.
- Relative or percentage spread: Quoted spread divided by the mid quote. Useful for comparing across price levels and securities.
- Effective spread: Twice the absolute difference between the execution price and the mid quote at the time of the order. This captures the actual cost paid or earned relative to the mid.
- Realized spread: Twice the absolute difference between the execution price and the mid quote observed after a short interval, often 5 minutes. This measure attempts to separate compensation for liquidity provision from subsequent price moves that may reflect information in the trade.
Effective and realized spreads require time-stamped quotes and trade data. They are often used in transaction cost analysis to understand how venue selection, order type, and market conditions influenced the final price paid.
Spread Behavior Across Assets and Conditions
Spreads are not uniform. They reflect asset characteristics, venue structure, and the news environment.
Highly Liquid Large-Cap Stocks
Large, widely traded equities often display the minimum tick spread during normal hours. Competition among liquidity providers and abundant two-sided interest keep spreads narrow and depth relatively stable. During the opening minutes and into the close, spreads can widen as order flow imbalances are resolved through auctions and as participants adjust positions.
Small-Cap and Illiquid Securities
Less liquid shares typically have wider spreads and shallower depth. A quoted spread of 25 to 50 cents on a 10-dollar stock is not unusual when daily volume is low. The wider gap compensates for the greater risk and cost borne by liquidity providers, and it reflects a thinner pool of natural counterparties.
Options
Options spreads vary with strike, maturity, and underlying liquidity. Contracts far from the money or with limited open interest can display wide spreads even when the underlying stock trades tightly. Market makers hedge option inventory with the underlying. When underlying volatility rises or hedging becomes more difficult, option spreads often widen.
Foreign Exchange and Crypto
Major currency pairs often show extremely tight spreads during peak London and New York hours, supported by deep liquidity across banks and electronic communication networks. Spreads widen during off-hours or around economic releases. In crypto markets, spreads vary with venue, pair, and time of day, and can widen sharply during high volatility or when exchange liquidity is fragmented.
ETFs and Their Underlying Baskets
ETF spreads reflect both supply and demand in the fund and the cost of arbitraging the fund price against its underlying basket. When the underlying components are illiquid or dispersed across time zones, ETF spreads can widen to reflect the cost and risk of creation or redemption.
Opening, Closing, and After-Hours Sessions
Spreads tend to be wider in the pre-market and after-hours sessions because participation is lower and fewer liquidity providers quote at size. Opening and closing auctions concentrate order flow to determine a single price. Before the open and after the close, off-auction quotes can be wide until the regular session consolidates more interest.
Tick Size, Price Increments, and Rounding
Exchanges specify minimum price increments, or tick sizes. If the tick is one cent, the narrowest possible spread in that market is one cent. Tick size can therefore bind spreads at a floor even when competition might otherwise compress them further.
Regulatory initiatives occasionally revisit tick size to encourage liquidity in small-cap stocks or to improve price discovery. Larger ticks can increase displayed depth at each level but may also set a wider minimum spread. Smaller ticks can intensify competition inside the spread but may fragment depth across many price points.
Hidden Liquidity, Midpoint Orders, and Price Improvement
Not all liquidity is displayed. Some venues allow hidden or iceberg orders, where only a portion of the total size is shown. Pegged orders can reference the bid, ask, or midpoint. A midpoint-pegged order aims to execute at the mid price, splitting the spread between buyer and seller. If a midpoint order interacts with a marketable order, the trade can occur at a price better than the quoted ask for a buyer or better than the quoted bid for a seller. This price improvement reduces the effective spread for the marketable side and the realized spread for the liquidity provider.
Because hidden orders do not contribute to displayed depth, the top-of-book quote may understate available liquidity. However, hidden liquidity is conditional and may not always execute when expected, particularly in fast conditions.
Broker Routing, Best Execution, and Payment for Order Flow
In markets such as US equities, brokers have obligations to seek best execution for client orders. This includes considering price, speed, and likelihood of execution. Brokers route orders to exchanges and alternative trading systems, some of which offer rebates for adding liquidity or charge fees for removing it. These maker-taker economics influence where quotes are posted and which venues supply the national best bid and offer at any moment.
Payment for order flow and internalization arrangements can affect execution quality. Retail-sized, marketable orders are often eligible for price improvement against the best displayed quotes. The difference between the quoted spread and the improved execution price shows up as a narrower effective spread for the marketable order. Execution quality reports and regulatory disclosures provide statistics on price improvement and spread-related outcomes across venues and brokers.
Spread Awareness in Trade Planning and Management
The spread influences several practical aspects of order handling and post-trade analysis:
- Position sizing and cost estimation: The quoted spread and visible depth provide a first-pass estimate of the immediate cost to open or close a position of a given size.
- Stop placement and execution mechanics: Because stops convert to marketable orders when triggered, spreads and quote stability affect where fills occur, particularly in gapping markets.
- Portfolio rebalancing: When many securities are traded at once, aggregate spread cost can be material even if each individual spread is small.
- Backtesting realism: Using last trade or mid quotes without accounting for spreads may overstate achievable prices in historical studies of execution quality.
- Intraday timing: Spreads often compress during periods of higher participation and widen during quiet intervals. This pattern affects expected execution cost throughout the trading day.
Common Misconceptions
- Misconception: A tight spread always means low execution cost. Clarification: Depth matters. A one-cent spread with minimal size can still result in significant cost if the order sweeps several levels.
- Misconception: If the last trade was at 50.00, selling should execute near 50.00. Clarification: The last trade is historical. The current bid and ask determine executable prices. If the book moved, execution follows the new quotes.
- Misconception: Price improvement is guaranteed on marketable orders. Clarification: Improvement is conditional on venue rules, counterparties, and available hidden interest. It varies across times and symbols.
- Misconception: Spreads are the same across venues. Clarification: Fragmented markets can show different top-of-book quotes on different venues until routing and arbitrage align them.
Numerical Examples
Example 1: Quoted and Percentage Spread
Quote: bid 50.00, ask 50.02. The quoted spread is 0.02. The mid is 50.01. The percentage spread is 0.02 divided by 50.01, or approximately 0.04 percent. A market buy executes at 50.02. If immediately sold at 50.00, the round-trip spread cost is 0.02 per share before fees.
Example 2: Effective Spread
Suppose the mid is 30.00, with a bid of 29.99 and an ask of 30.01. You receive an execution to buy at 30.005 on a midpoint-pegged order. The effective spread is 2 times the absolute difference between 30.005 and 30.00, or 0.01. You captured half the quoted spread because the trade occurred at the mid.
Example 3: Depth and Partial Fills
Bid 25.00 for 200 shares, next bid 24.98 for 500. Ask 25.02 for 100 shares, next ask 25.05 for 1,000. A market buy for 500 shares fills 100 at 25.02, then 400 at 25.05. The volume-weighted average price is 25.044. Although the quoted spread was 0.02, the realized cost exceeded that because the order consumed limited size at the top ask and then lifted the next level.
Example 4: Stop Order in a Moving Market
Current quote 40.10 by 40.12. A sell stop at 40.00 triggers as the price declines quickly. By the time the order converts to a marketable sell, the quote is 39.96 by 39.98. The fill occurs near 39.96, which reflects the current bid at the trigger moment. The spread at the time of execution influences the exact outcome.
How Spreads React to Information
During scheduled announcements such as earnings releases or macroeconomic reports, prices can update faster than liquidity providers can maintain tight quotes. Spreads widen to reflect heightened uncertainty and to protect against adverse selection. As the information is digested and two-sided interest returns, spreads often normalize.
Unscheduled news produces similar patterns, with the added complication that not all participants receive or interpret the news at the same time. In those intervals, the spread embeds compensation for bearing information risk until new prices are discovered.
Data, Displays, and Practical Monitoring
Market data packages range from simple top-of-book quotes to full depth-of-book feeds with millisecond time stamps. A basic screen showing bid, ask, and last trade can be sufficient for many contexts, but it abstracts away depth and hidden interest. Level 2 displays reveal multiple price levels and sizes, which helps gauge how far a marketable order might travel through the book.
Some tools show the spread as a dynamic time series, alongside percentage spread. Viewing the spread this way highlights diurnal patterns such as wider spreads at the open and around news, and tighter spreads during midday consolidations in active stocks. These patterns are contextual rather than universal and vary by symbol and venue.
Fees, Rebates, and the Economic Meaning of the Spread
Exchanges and venues often use maker-taker pricing. Adding liquidity might earn a small rebate, while removing liquidity pays a fee. The net economics for a liquidity provider are the realized spread minus exchange fees, minus inventory and hedging costs. For a liquidity taker, the true cost includes the effective spread plus venue fees. These cash flows help explain why spreads can be persistently tight in highly competitive markets and wider where competition is sparse.
Cross-Asset Comparisons
It is helpful to interpret spreads relative to typical volatility and trade size in a given asset class:
- On-the-run government bonds: Very tight spreads on electronic platforms during liquid hours, supported by active primary dealers and interdealer brokers.
- Corporate bonds: Wider and more varied because many issues trade infrequently. Dealer inventory and client inquiry processes influence observed spreads.
- Futures: Often display one tick spreads in active contracts during liquid hours, with deep order books around key price levels such as round numbers or prior settlement zones.
Putting It Together
The bid-ask spread connects microstructure, risk, and the day-to-day practice of placing orders. Quotes form from competing limit orders. Marketable orders pay for immediacy by crossing the spread. In liquid periods with deep books, spreads are narrow and execution is more predictable. In thin or volatile periods, spreads widen and depth becomes crucial. Tools such as percentage spread, effective spread, and realized spread translate these ideas into measurable quantities that can be evaluated over time and across venues.
Key Takeaways
- The bid-ask spread is the explicit price of immediacy, equal to the ask minus the bid at a point in time.
- Spreads compensate liquidity providers for risk, costs, and information asymmetry, and are constrained by tick size.
- Execution outcomes depend on both spread and depth, with large or fast orders often realizing costs beyond the quoted spread.
- Effective and realized spreads provide more informative measures of actual trading cost than the quoted spread alone.
- Spreads vary across assets, venues, and market conditions, typically widening during uncertainty and tightening when two-sided interest is strong.