Everybody wants to get the best deal – whether it be for security, asset, commodity, or service.
When it comes to trading in the stock market, savvy traders carefully select the ideal price point at which they wish to purchase or sell an asset. However, if their chosen level strays too far from current market prices, execution of that order is not guaranteed.
When a buyer and seller come together, the bid price typically falls below their desired asking rate. The resulting gap between these two figures is known as the ‘bid-ask spread’.
What Is A Bid Price?
The bid price is the price that a buyer is willing to offer in order to purchase the asset from a seller in a transaction. From the position of the seller, the bid price is the value at which they are willing to purchase the asset from the trader.
When trading financial assets, traders must be aware of the bid-ask spread – essentially the ‘price’ for entering a position. This is calculated by comparing two values quoted in order: the bid price and the offer price.
Bid Price Examples
Let us examine how it works by looking at two examples, one for shares and the other for forex.
For instance, if Apple stock is trading at $140.50, with an offer price of $140.60, and a bid price of $140.40. If you think the price will fall, you decide to open a CFD position by shorting, or selling, five contracts at the bid price of $140.40.
After a few days, the stock price falls to $137.40, with a bid of $137.20, and an offer of $137.60. By this being the case, you’ve made a profit with the price paid from your decision to go short and you close your position by buying five contracts at the current offer price of $137.60.
Now, let’s consider forex. Heeding the latest Federal Reserve interest rate announcement, you seized upon an opportunity in foreign exchange by correctly predicting that the value of EUR/USD would decrease. With this insight, you opened a CFD position – selling five contracts at $1.2420 – which quickly paid off when EUR/USD fell to $1.2220 after just a few days and enabled your profit-taking via reversing your trade with five purchases of contracts at $1.2250.
Understanding Bid Prices
The bid price refers to the highest amount of money that a buyer is willing to pay for a security. It is usually contrasted with the ask or offer price. Which is the highest amount that a seller is willing to sell a security for. The difference between these two prices is known as the spread, which is how market makers (MMs) make a profit.
Bid prices can be used strategically by buyers to achieve a desired outcome. For example, a buyer might make a bid that is lower than the asking price. However, it still higher than what they are willing to pay, to appear as if they are compromising and giving up something.
When multiple buyers put in bids, it can lead to a bidding war. In this scenario, buyers place incrementally higher bids, until a price is settled upon when a buyer makes an offer that their rivals are unwilling to top. This benefits the seller as it puts pressure on buyers to pay a higher price than if there was only one prospective buyer.
Bid vs Ask Price
The bid and ask prices are the pulse of the market. They communicate what buyers and sellers deem to be a fair price for any security at that particular moment. Through these dynamic quotes, traders gain insight into prevailing market conditions. As a result, to make informed decisions on when is best to buy or sell their securities.
Bid and ask prices are crucial concepts that many retail investors tend to overlook while trading. It’s important to understand that the current stock price is the price of the last trade, a historical price. However, both the bid and ask prices are the prices that buyers and sellers are willing to trade at.
In simple terms, the difference between the bid prices represents the demand for security or the highest price. While ask prices represent the supply or the lowest price.
For instance, let’s say the current stock quotation shows a bid price of $13 and an ask price of $13.20. An investor looking to buy the stock would pay $13.20. Whereas, an investor looking to sell the stock would sell it at $13.
Buying and Selling at the Bid
Investors and traders can make the most of their securities purchases with two types of orders. These are market orders for quick buy/sell transactions, or limit orders to get exactly the price they want.
For investors and traders seeking immediate execution, market orders are the way to go. When buying, you’ll simply pay the current ask amount in exchange for swift transaction. However when selling, receive an equitable return with just as speedy a resolution.
On the other hand, Limit orders provide investors and traders with an advantage; they can leverage the bid or asking price to get better offers for their buy or sell transactions.
For instance, let’s say an investor or trader wants to buy a stock at $20. But the ask price is currently higher than that amount, so in this case they can place a limit buy order. This will only be executed if and when the stock drops to their desired purchase price of $20.
In contrast, placing a market buy order would require them to pay the current asking price. In this example it’s $21. The same principle applies for selling. With a limit sell option set at your desired sale figure ($25), you’ll receive that exact amount as soon as (or if) the bid rises up to meet it; otherwise opting for ‘market’ lets you accept what buyers are offering right now ($24).
