Spread Definition: Day Trading Terminology
Buying a stock is not the same as buying something from the supermarket. Instead stocks are bought and sold according to the bid/ask spread, which is the difference between the highest bid, or the highest price that someone is currently willing to buy at, and the lowest ask, or the lowest price that someone is currently willing to sell at.
It is the difference between the current bid and ask quotes, and every trade will take place somewhere within the limits of the bid, ask or in between.
Stock Transactions and the Spread
Any actual stock trade must take place somewhere within the limits of the bid/ask.
If someone is willing to buy a stock at any price or market price, then they will pay the ask price to buy the stock from the seller offering the lowest current price to sell the stock. If someone is willing to sell a stock at any price, then they will receive the bid price from the buyer offering the highest current price to buy the stock.
Therefore, a market clearing price is achieved whenever the bid and ask prices meet and the spread goes to zero. Everyone who wishes to transact at this price will trade until all the volume is gone, and then the spread will return to a positive sum with some space existing once again between the bid and ask prices.
The spread is an important concept for traders to understand as we receive a lot of questions for why they didn’t get filled a price they thought they were due but didn’t realize there was a huge spread on the stock. Moreover, if you are buying a stock at the ask price and selling at the bid price, that is an automatic deduction from any potential profits that you might make on that trade.
Finally, the spread can widen substantially during times of high volatility, which can make getting into a trade very difficult if prices are not carefully monitored.
Traders should be comfortable with the dynamics of the spread for the types of stocks that they trade, as the mechanics of how a stock is transacted around it can make the difference between a profit and a loss, no matter how well-informed a trade may otherwise be.