Understanding the Ask Price
The ask price represents what a seller is willing to accept for a security, often called the offer price. Alongside the ask price, the quote might specify the number of securities ready to be sold at this price. The bid, conversely, is what a buyer is prepared to offer, and it’s always lower than the ask.
Here’s an example: in the stock market, an offer might appear as ‘5.24 x 1,000,’ meaning someone is offering to sell 1,000 shares at $5.24 per share.
Key Takeaways
- Offer Price: Another term for ask price.
- Bid vs. Ask: The bid is always lower than the ask.
- Spread: The difference between the bid and ask prices.
- Spread Variation: Different markets have different spread conventions, reflecting transaction costs, the value of a point, and liquidity.
The ask is consistently higher than the bid, and the gap between the two is the spread. A wider spread can make profits elusive as securities are bought at the high end and sold at the low end. Spreads can widen with market volatility or uncertainty.
The Evolution of Stock Market Spreads
In 2001, stock price quotations shifted from sixteenths of a dollar to decimals, reducing the smallest possible spread from 1/16 of a dollar (0.0625) to a penny. The nominal spread’s width partially depends on the stock price; a two-cent spread on a $10 stock equals 0.02%, while the same spread on a $100 stock is just 0.002%.
Understanding Foreign Exchange Spreads
Spreads are narrower in the wholesale market where financial institutions trade. These spreads differ by currency. For instance, when trading euros for dollars, the spread is typically 1-2 points. If the bid is 1.3300 (dollars per euro), the ask might be slightly higher at 1.3301. Even a single point can have substantial value; at a EUR/USD rate of 1.3300 for a $10,000,000 transaction, it’s worth $751. For the Japanese yen at 110 JPY/USD, a point is worth $909.
Spreads are generally wider for cross-currency transactions compared to trading against the dollar, reflecting lower trading volumes and higher volatility. The increased use of electronic dealing systems in retail markets has compressed spreads significantly, sometimes reducing them to 3-10 points.
Exploring Bank Note Spreads
The market for buying and selling foreign currency banknotes operates separately from the wholesale or retail forex markets. In this arena, spreads are often larger, frequently reaching 75 pips or more.
Related Terms: bid, liquidity, foreign exchange, derivative, spread.
References
- U.S. Securities and Exchange Commission. “SEC Concept Release: Request for Comment on the Effects of Decimal Trading in Subpennies”.
