DO/DID YOU KNOW?
The Bid/Ask Trap
In our Do or Did You Know? blogs we provide readers with useful information that generally is not realized by inexperienced investors. In Chapter 6 of our publication, When to Buy and When to Sell: Combining Easy Indicators, Charts, and Financial Astrology (available on Amazon), we introduce briefly touch on the BID and ASK prices of an equity.
The Bid/Ask is simply the current price buyers are willing to pay for shares (Bid) and the price sellers are requesting to release their shares (Ask). The actual difference between the two is known as the Spread.
The spread is always changing throughout a trading day, as “market makers” constantly adjust their asking price. Some equities possess very narrow spreads, while others are much wider. Generally, large cap stocks with high liquidity, and rapidly moving prices, have smaller spreads, while smaller cap, slower moving equities will often have larger spreads.
Have you ever wondered why a position can be immediately in the negative, despite the fact that you placed a “market” order to purchase, and were immediately filled? The answer is … the spread.
For example – Stock A on your watch list is trading at $30. You have completed your analysis and decided to purchase 100 shares of this slower moving equity. The commission-free “market” order is placed, and is filled within a second. Upon checking your profit/loss column (P/L), it indicates -$5.00. What happened?
This scenario suggests that the spread may have been at least 5 cents. If the BID was $30, matching the trading price at the time, but the ASK was $30.05, the “market” order will be filled at the ASK price. For the longer-term investment or trade, the difference is rather insignificant. However, for a day-trader/scalper the difference can be significant, as options or much larger share sizes are usually involved.
As the Bid/Ask are always fluctuating, it may be more beneficial to place a “limit” or “stop-limit” order, if a “specific” price or a “not to exceed” price is desired. As also discussed in our publication, the “limit” price will be filled at any price “at or better than” the requested price, while the “stop-limit” will be filled ONLY at that price. These orders protect the trader from overpaying, and are true purchase or sell levels. Thus, the slow-moving stock will likely remain at the fill price at the outset.
Additionally, day-traders should pay close attention to the spread, as they prepare to enter a position. Comparing the current price to the spread is often a leading indicator to price direction in the very short term. Most platforms will highlight the bid and ask, (right next to the current price) in red and green. Traders will often use the color-coded spread to determine if the immediate direction is up or down. When the bid/ask turns red, the price is normally headed downward toward or below the bid, while when green, price is usually headed up or toward the ask. The spread moves fast for high cap stocks so be careful when attempting to trade this action. Starting with slower moving, smaller cap stocks, that are liquid, is suggested.
Remember, the price of any asset “is what it is” at any moment in time, so it may be important to pay exactly what one intended to pay at the time of the trade.
*** This information is not intended to be financial advice, and should be considered or any specific buy or sell recommendation, but rather a guide to assist the reader in some further understanding of the financial markets.
