Bid, ask and spread in trading.

Bid, ask and spread in trading

Let us start from a puzzle:

Ask and Bid made a flight on a bee,

Ask dropped when the bee suddenly stopped

Bid fell onto grass, can’t be seen by none of us

Guess what’s left on the bee when it sat?

You are right, it’s a brave lovely …!

The end of this amphigory is in the end of this article, which is about ask, bid and spread. It is not funny at all when traders do not understand such basic concepts. By the way, analysis of bids and asks could be very useful when identifying price turnarounds, as you will see further.

Before we speak about bid, ask and spread, let us refresh our understanding of such fundamental concepts as supply and demand. Supply is a quantity of goods a seller wants to sell. Demand is a quantity of goods a buyer wants to buy.

Pursuant to the supply and demand law: “all other conditions being equal, the lower the price, the higher the effective demand is and the lower the supply is”.

Let us consider an example to see how supply and demand interact.

Let us assume that somewhere in Africa a miner found a diamond of a large size. An interested buyer learned about it and offered the miner USD 1 million for it. The miner asked for two days to scratch his head. However, information about this diamond leaked into the press, which resulted in other interested persons. The miner received an offer of USD 1.1 and rejected the previous USD 1 million offer. Two more potential buyers offered him USD 1.2 and 1.3 million respectively. So, the demand increases. The demand price is the bid price, or the price, at which buyers are ready to buy a commodity. Bid means an offered price.

Next day, miners in Asia found 10 diamonds of the same size, as was the African one. Immediately after this information became public, the price and demand on the African diamond fell down due to availability of a big quantity of similar diamonds.

Bid, ask and spread in trading

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What a bid is

The bid price is the demand price or the price, at which a buyer agrees to buy a commodity. A buyer does not want to buy at a high price. This is the logic of the law of supply and demand.

What an ask is

The ask price is the supply price or the lowest price, at which a seller agrees to sell a commodity. A seller does not want to sell at a low price.

A seller increases the ask price when new factors appear, which increase the market value of a commodity. A buyer realizes that he has small chances to buy this commodity at a previous price and has to increase the bid price. And the situation is opposite when the market price goes down. A trade is executed only when there is a buyer who is ready to pay immediately the whole amount requested by a seller. Or a seller agrees to take that amount of money, which a buyer is ready to pay.

How does it look during exchange trading?

The trading ATAS platform has the Bid Ask indicator, which shows how many trades were traded at the ask price and how many – at the bid price during a certain period of time.

You can use this link to find reference information on the Bid Ask indicator.

How to use the bid/ask indicator data

How to use the bid/ask indicator data

The picture above shows a 5-minute chart of the oil futures trading on the Moscow Exchange. The Bid/Ask indicator is shown in the lower part of the chart in a form of a bar chart. Pay attention to the indicator behavior on the price upward turnaround from under the 80 level. Assess 17:20 indicator data. Predomination of the green color says that the market registered more purchases at the ask price (namely, 20,918 lots were bought). For comparison, there were significantly less sales at the bid price (the red column is much smaller, namely, 6,184 lots were sold). As a result, an intraday rally to 80.80 level was started.

Accumulation of purchases at the bid price is one of the attributes of availability of initiative major traders. Download and install ATAS, monitor the beginning of the upward trends with the help of the Ask/Bid indicator and you will see the similar behavior practically on each bottom. The price levels, at which such a pattern is formed, play the role of the support levels in future.

One more way of visual detection of the market buying and selling imbalance is the use of the Bid/Ask Imbalance when adjusting the cluster (you can find more details about the Bid/Ask Imbalance cluster type in the respective section of the ATAS knowledge base).

Here is the same chart in the form of the Bid/Ask Imbalance clusters:

Bid/Ask Imbalance clusters:

Look, the number of sales exceeds the number of purchases practically at each price level. This testifies to undervaluation of the Brent oil futures contract at the level of about USD 80 a barrel.

To have a completely clear picture, it is necessary to understand what main types of trading orders exist:

  • Market orders are orders at the current price. These are orders of those traders who are in a hurry to buy/sell immediately at the best price, which is available in the market, that is at the bid or ask price. Such orders will be executed very fast.
  • Limit orders are orders at a previously specified price. If you do not hurry to buy and are prepared to wait for a better price, your choice is the buy limit order. For example, the plan is to buy at the level of the yesterday’s low and sell at the level of the yesterday’s high. You will get profit if both limit orders are executed. But they might not be executed if the requested price does not find the willing ones. Then the trading result will be zero. But it is better than a price fall loss after execution of the buy limit order.

By the way, the ATAS platform users have a possibility to buy/sell at bid/ask prices with one mouse click directly from the screen or through a special menu, which significantly accelerates the process of trade execution. You can get acquainted with the Chart Trader functions in this article

WHAT IS A SPREAD?

Spread is a difference between the ask and bid prices

Sometimes, when analyzing a chart, the spread term means a difference between the high and low of a bar/candle. Spread is a range, expansion and amplitude.

Spread is a range, expansion and amplitude.

Even a novice can easily see the spread in the trading and analytical ATAS platform with the help of the Depth of Market indicator

Spread with the help of the Depth of Market Indicator

It is a convenient graphical presentation of limit orders at each price level. By default, the bids are green and asks are red.

Let us consider one example. One of your neighbors, William Johnson, wants to buy 10 kilos of potatoes at USD 10 – this is the bid price. Another neighbor of yours, John Williamson, wants to sell 15 kilos of potatoes at USD 11 – this is the ask price. The spread between these prices is USD 1 (USD 11 minus USD 10). If William Johnson and John Williamson both would have made a trade-off, they could have executed the trade immediately. But they both use limit orders, they are not in a hurry and do not want to make a trade-off.

The more sellers are there in the market, the more selling orders would be posted by them at a higher level than the market price (the price of the most recent registered buy/sell trade). A competition will grow among sellers and, while trying to sell their goods, they would have to decrease the price of their offers. Thus, the bid prices move closer to the current market price.

And, respectively, the more buyers, the bigger is the number of buying orders in the market and the ask price moves closer to the current market price.

If there are more prices, the liquidity is higher and the spread is narrower. If there are less prices, the liquidity is lower and the spread is wider. Liquidity is a possibility to sell fast with a minimum spread between the bid and ask prices.

For example, an OJSC MMC Norilsk Nickel (Nornickel) common stock futures is a less liquid instrument on the exchange than a Brent oil futures.

OJSC MMC Norilsk Nickel (Nornickel) common stock futures

A spread is always a bit of a disappointment for a minor trader, since it increases expenditures in trading.

It is like a currency exchange shop – the selling price of any world currency is always higher than the buying price. It is absolutely unprofitable for currency buyers, but very profitable for a currency exchange shop.

What a spread in the currency trading is.

Let us assume that the Guinean Franc (GNF) is traded at USD 9.95-10. The bid price is USD 9.95 and the ask price is USD 10. The spread in this case is 5 cents or 0.5% (0.05/10). The buyer who will buy GNF for USD 10 through a market order (at the ask price), would lose 0.5% on this trade due to the spread. Buying GNF 100 would bring USD 5 of losses and GNF 10,000 – USD 500 of losses. Similarly, the seller will have losses when executing a market order at the bid price. It is obvious that a trader should consider the spread influence on the final result in the long run.

Spreads and prices become very ‘active’ during:

  • publications of important economic news and statistical data;
  • when the market is opened and closed;
  • when officials make speeches.

Such events are accompanied with the increase of liquidity. A number of traders is big (for different reasons): the buyers consume the closest asks and the sellers – closets bids. It is believed that trading directly at these moments has a higher risk.

How to reduce expenditures connected with the spread:

  • to use limit orders;
  • to calculate the size of your order with consideration of the available offsetting orders;
  • to trade around narrow spreads, that is in the liquid markets.

And now we come back to our puzzle.

Ask and Bid made a flight on a bee,

Ask dropped when the bee suddenly stopped

Bid fell onto grass, can’t be seen by none of us

Guess what’s left on the bee when it sat?

You are right, it’s a brave lovely spread!

The answer is spread.

We hope the article has been useful for you. Still have questions? Post them in the comments and we’ll be glad to answer them.

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