Bid–ask spread
The bid–ask spread (also bid–offer or bid/ask and buy/sell in the case of a market maker) is the difference between the prices quoted (either by a single market maker or in a limit order book) for an immediate sale (ask) and an immediate purchase (bid) for stocks, futures contracts, options, or currency pairs in some auction scenario.
For a round trip (a purchase and sale together) the liquidity demander pays the spread and the liquidity supplier earns the spread.
On these exchanges, and even on NASDAQ, institutions and individuals can supply liquidity by placing limit orders.
The bid–ask spread is an accepted measure of liquidity costs in exchange traded securities and commodities.
On any standardized exchange, two elements comprise almost all of the transaction cost—brokerage fees and bid–ask spreads.
Under competitive conditions, the bid–ask spread measures the cost of making transactions without delay.
This spread is often expressed as a percent of the midpoint, that is, the average between the lowest ask and highest bid:
[3] Effective spreads account for this issue by using trade prices, and are typically defined as:
The effective spread is more difficult to measure than the quoted spread, since one needs to match trades with quotes and account for reporting delays (at least pre-electronic trading).
[4] Quoted and effective spreads represent costs incurred by traders.
The intuition for why this spread measures the cost of immediacy is that, after each trade, the dealer adjusts quotes to reflect the information in the trade (and inventory effects).
If the USD/JPY currency pair is currently trading at 101.89/101.92, that is another way of saying that the bid for the USD/JPY is 101.89 and the offer is 101.92.
Gold and silver are known for having the tightest bid-ask spreads, making them useful as money, while other metals may have wider bid-ask spreads due to lower trading volumes, less liquidity, or large fluctuations in supply and demand.
For example, rare metals like platinum, palladium, and rhodium have lower trading volumes compared to gold or silver, which can result in larger bid-ask spreads.
