Understanding the Bid Price vs Ask Price
Stocks, cryptos, and other investments may have been far removed from everyday people in the past, but that is not the case today. With increased education, individualism, and skyrocketing prices, more and more people are looking for alternative, more sustainable ways to supplement their main income.
It’s estimated that over 61% of Americans invest in stocks, showing how stocks are becoming available to more people. In contrast, almost 7% of the entire global population owns cryptocurrencies. This shows the growing interest in diversifying assets.
Understanding how the financial markets function takes time and effort, but if you’re interested in learning more, one of the first things you’ll hear about will be bid price and ask price. Let’s explore this concept, and look at some examples.
Table of contents
What Is Bid Price vs Ask Price
In the most basic sense, the bidding price is the highest amount a person is willing to pay for an asset. The asking price is what the seller is willing to accept. This concept is related directly to supply and demand and isn’t exactly new – it’s been around for a long time.
To expand a bit more on the historical evolution of bid vs ask price, the concept became standardized when formal exchanges like the Amsterdam Stock Exchange (early 1600s) and the New York Stock Exchange (in 1792) were established.
Brokers and market makers (companies or individuals who provide liquidity by quoting bid and ask prices) became prominent in these exchanges, helping facilitate smooth trades. Today, however, digital exchange platforms like Interactive Broker for stocks or Paybis for cryptocurrencies have become the new standard, allowing users to review a vast amount of information and trade with ease.
Difference Between Bid and Ask
The bid and ask difference, or the amount a buyer can pay and the seller can accept for an asset is known as the bid-ask spread. This spread represents a specific cost for traders because when a person buys, they typically pay the ask price. But when a person wants to sell assets, they get the bid price. This creates the grounds for the overall transaction cost for an asset.
The bid and ask spread can be wide and narrow. For example, a narrow spread usually indicates high liquid markets with higher trading volumes. This means that people can purchase assets more easily. A wider spread, on the other hand, happens when the markets have lower liquidity, which in turn leads to higher price ranges and volatility. To sum up, the bid-ask spread is used as a measure to evaluate how efficient markets are.
Bid and Ask Meaning
As we already mentioned, the bid and ask prices show the demand and supply dynamic, and influence the financial markets. Here’s a brief rundown of the key factors that are impacted by the bid and ask dynamic:
- Market liquidity. A narrow bid-ask spread usually indicates high liquidity, resulting in a more stabilized environment for purchasing and selling assets. Wider spreads show low liquidity, making it more difficult to trade due to higher prices.
- Price discovery. The bid and ask prices reflect the current market price for an asset, allowing buyers and sellers to settle on a certain price that’s generally accepted in the market.
- Trading costs. The bid-ask spreads have a huge impact on transaction costs. Buyers, especially day traders, have to observe the market price changes carefully as a wider spread can lead to higher transaction costs.
- Market volatility. When there’s a disagreement on an asset’s price, it can lead to a severe imbalance, resulting in high volatility and more expensive trades. This is especially evident with crypto prices.
Comparing Bid vs Ask Price
Now that we have a theoretical background on bid and ask prices, let’s look at some actual examples to help cement the concept.
Example 1: Crypto Market
So, you’re looking to sell some of the most popular cryptocurrencies, like Bitcoin. For this example, let’s say you want to sell a single BTC for the US Dollar on a crypto exchange.
One Bitcoin is currently worth a lot, so if you’d want to sell a single BTC, it would be around $95K (the price is subject to change rapidly. This would also be the bid price or the highest amount a you’d be willing to pay. However, you might ask for $96K, creating a spread of $1000.
Example 2: Stock Market
Let’s say you’re a starting investor and you’d like to buy a stock from an established and well-known company like Apple Inc. (AAPL). A single share is currently worth around $260, so this would be the highest price you’d want to pay for that sharing, making this a bid price.
Depending on the stock exchange platforms you’d use, the ask price could be $261. This would create a very narrow bid vs ask spread of $1.
How Are Bid and Ask Prices Set?
The simplest way to explain how these prices are set is to look at the scarcity of a single asset. Scarcity is a major factor in determining supply and demand, and bid vs ask price. When an asset is scarce or there’s a limited supply, the demand tends to increase, which also increases prices.
This created a gap or a wide bid vs ask spread. At the same time, if there’s a large amount of a specific asset, its’ demand reduces, narrowing the spread. Scarcity is crucial for balancing the extreme differences in demand and supply. Additional factors that may influence bid and ask prices are:
- Market liquidity. A higher liquidity usually signifies narrower spreads and more balanced asset prices.
- Order size. Sometimes, large trades of a single or multiple assets can significantly change the spread between bid and ask prices.
- Market makers. These individuals or entities help balance the markets by continuously quoting bid and ask prices to ensure there’s always a buyer and a seller for a given asset, which also results in a market maker’s profit.
- News and events. This factor is huge in the crypto market as cryptocurrencies aren’t backed by central banks, making community hype, interest, and support crucial.
Wrapping Up
Whether you’re just starting to tap into the financial markets or you’re a seasoned trader of assets, both physical and digital, it’s important to understand the nuances between supply and demand. Learning about what is bid price vs ask price will not only make you more prepared to achieve better results, but it will also help navigate market changes and avoid unnecessary losses.
FAQ
Do customers pay the bid or ask price?
Customers who are looking to buy an asset are the ones who pay the ask price if it’s within their budget and the ask price is more or less similar to other sellers’ prices. In short:
- The ask price is the lowest price a seller is willing to accept.
- The bid price is the maximum price a buyer is willing to pay.
How to calculate bid and ask price?
The bid and ask meaning doesn’t determine the current price of an asset; it represents the market sentiment at a specific time for an item or asset. When there’s a limited supply of an asset, demand increases, and so does the price. But if the supply is stable or increases, prices drop.
What is the best bid and ask price?
The best bid and best ask prices are basically the highest price a buyer is willing to pay and the lowest price a seller can accept. This way, the best bid price is essentially the highest bid price in the order book, creating a narrow spread and a favorable purchasing environment.
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