UNDERSTANDING BID-ASK SPREAD
The bid-ask spread is the difference between the bid price and ask price of an instrument. That spread is a significant factor one should take into consideration when investing. But, in some instances, traders fail to realize the underlying cost of investing in any security. Understand more about the bid-ask spread by reading some facts about it.
Bid-ask spread signifies a cost which is not evident to beginners. While this cost may not be that significant for traders who do not often place orders. But it can denote a higher fee for investors who trade regularly.
Spread is comprised of liquidity, supply, and demand. Granted an instrument’s supply and demand has no huge disparity, the most frequently traded securities usually have tightened spreads. Contrarily, the gap between the two prices will widen if a security exhibits considerable discrepancy and low liquidity level.
Majority of US stocks were appraised using fractions. One-sixteenth of a US dollar, or 6.25 cents, was the smallest price movement seen in a price quote. But the decimalization in 2001 has constricted the spreads on American stocks. As of present, many stocks now enjoy bid-ask spreads which are much lower than before.
Supply and demand have great distinction as sellers assume the bid and purchasers move away since they are expecting lower rates. Expect spreads to broaden when the market slumps. Two rationales: in times of volatility, the market attempts to discourage traders from placing orders and ease the greater risk of losing.
Whilst erratic market movement is inevitable, we can limit its effect at the very least.
Be friends with limit orders. Using a limit order enables an investor to determine a price cap for purchasing or selling an instrument. Most applicable in fast-paced markets, placing this order can lead to higher than anticipated price for purchasing and lower than expected price for selling.
Look for the smallest bid-ask spread. Not every retail forex traders can afford to take wider spreads. Good thing several brokers offer minimal spreads, improving chances of booking successful trades.
Stay away from liquidity fees. Limit orders help avoid paying unnecessary charges levied by many electronic communication networks or ECNs.
- Review spread percentages. Take note of this rate especially when using leverage or margin.
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