Bid/ask spread

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In a liquid market, such as those for stocks and bonds, there are many buyers and sellers willing to pay and accept different prices. An offer from a potential buyer for an item is called a bid. An offer from a potential seller is called an ask. The market price is the price of the last sale, when a bid equaled an ask. At any moment, the difference between the highest bid and the lowest ask is called the bid/ask spread. For example, if the most eager buyer is willing to pay $20.50 for a share of Microsoft, and the most eager seller is willing to accept $20.52, then the bid/ask spread spread is $0.02.

An investor who decides to place a market order for Microsoft will pay the ask, $20.52 in this example. Let's say that a week later, the stock's bid and ask prices have returned to the same levels, and the investor decides to sell their shares, again placing a market order. They will receive the bid price, which is $20.50. Thus, even though the market has not changed, the investor will have paid $0.02 per share in spread. This expense is in addition to any commissions the investor may pay their broker.

Foreign exchange markets are the most liquid, and often have spreads of a hundredth of a cent. The municipal bond market is notoriously illiquid, and can have spreads of several percent of the value of the bonds.

In less liquid markets like those for bonds, individuals may pay a higher spread than institutions, which are able to negotiate more favorable terms with their higher volume.

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