Bid Ask Spread: How It Works in Investing With Examples

The bid-ask spread describes the gap between the price buyers are offering for a security and the price that sellers are willing to accept. This difference develops from supply and demand, trading activity and the presence of market makers who provide liquidity by standing ready to buy and sell. When these participants purchase at the bid and sell at the ask, the spread can serve as compensation for the risk and cost of facilitating trades. Securities that trade frequently tend to show narrower spreads, while those with lighter trading volume or higher volatility often show wider ones.

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What Is a Bid Ask Spread?

A bid-ask spread exists because buyers and sellers enter the market with different price expectations at any given moment. Buyers submit bids reflecting the maximum theyre willing to pay Meanwhile sellers post asks showing the minimum they’ll accept. Trades occur only when those prices meet, either because one side adjusts its price or accepts the other side’s offer.

The size of the spread varies based on how easily a security can be traded. Stocks with heavy trading volume and broad investor interest tend to have small price gaps. This is because there are many competing buyers and sellers. In contrast, securities with limited activity, complex structures or higher uncertainty often show larger spreads as participants demand more favorable pricing to transact.

The spread also reflects short-term market conditions. During periods of rapid price movement or limited liquidity, quoted prices can move apart as participants react to new information. As conditions stabilize and trading activity resumes, spreads often tighten again.

How to Calculate a Bid Ask Spread

To calculate the bid-ask spread, subtract the highest price buyers are offering for the security from the quoted selling price. So, for example, if a stock shows a bid of $40.00 and an ask of $40.05, the spread is $0.05.

This figure can be expressed in absolute dollar terms. Or, in some cases, it appears as a percentage of the ask or midpoint price. This allows for comparisons across securities with different price levels.

Quoted spreads reflect the prices currently available in the market. However, the effective spread an investor experiences can differ slightly based on order size and execution timing. Larger or less common trades may fill at multiple price levels, widening the actual cost.

Regardless of format, the calculation itself is straightforward. It isbased entirely on the difference between the best available buying and selling prices at a given moment.

Understanding the Role of Market Makers

Market makers are firms or individuals that commit to continuously quoting prices at which theyre willing to buy and sell a security. By doing so, they add liquidity to the market, making it easier for other participants to enter or exit positions without waiting for a matching order. This helps keep trading orderly, particularly in markets where buyers and sellers may not arrive at the same time.

Bid-ask spreads are closely tied to how market makers operate. When a market maker posts both a bid and an ask, the difference between those prices reflects compensation for providing immediacy, managing inventory and bearing short-term price risk. If a security trades actively and competition among market makers is strong, these price gaps tend to shrink. Fewer participants or uncertain price conditions can lead to wider spreads.

Market makers also adjust their quotes as market conditions change. Shifts in volatility, trading volume or new information can prompt them to widen or narrow spreads to reflect updated risk and demand.

Examples of Bid Ask Spreads

Imagine a heavily traded stock showing a bid of $50.00 and an ask of $50.02. If an investor submits a market order to buy, the trade typically executes at $50.02, the lowest price currently offered by sellers. A market order to sell would fill at $50.00, the highest price buyers are offering. The two-cent difference reflects the trade-off for immediate execution.

If a market maker buys shares at $50.00 and later sells at $50.02, that two-cent difference can contribute to their revenue. However, this outcome depends on prices remaining stable long enough for both sides of the trade to occur.

Contrast that with a lightly traded stock quoted at $50.00 bid and $50.50 ask. With fewer participants posting prices, buyers and sellers are farther apart. An investor who buys at $50.50 and later sells at $50.00 would realize that gap as part of the round-trip trading cost.

Order type also matters. Using a limit order allows an investor to set a specific priceThis potentially reduces the impact of the spread, though there is no guarantee of execution. Market orders prioritize speed, while limit orders prioritize price. The bid-ask spread determines how those choices play out in practice.

Trade-Execution Obligations

When a broker or market maker posts a bid or an ask, that quote represents a standing commitment to trade at that price for the displayed quantity, subject to market conditions and exchange rules. In practical terms, this means that when a matching order reaches the market, the quoting firm is generally required to honor the price shown.

For individual investors, this process happens behind the scenes, but it directly affects the price at which trades are filled. Buying at the ask and selling at the bid is the normal cost of immediacy. While investors cannot control the spread itself, they can control how they participate in it through order selection and timing.

Rather than focusing on short-term price movements alone, investors typically evaluate whether the expected return of a trade justifies the transaction costs created by the bid-ask spread. For example, if a stock is quoted at $9 bid and $11 ask, and an investor believes its fair value is meaningfully higher, the two-dollar spread becomes part of the cost of entering the position. If the stock later trades at $12, the investor has gained $1 per share beyond that entry cost. If it rises to $24, the spread becomes relatively insignificant compared with the overall gain.

In this way, trade execution is less about predicting small price changes and more about aligning entry and exit decisions with long-term expectations.

Types of Security Orders

Order type plays a central role in how investors interact with the bid-ask spread. Different orders balance speed of execution against price control.

Market order: A market order instructs the broker to execute immediately at the best available price. This prioritizes execution speed but exposes the investor to paying the current ask when buying or receiving the current bid when selling.
Limit order: A limit order sets a specific price at which an investor is willing to buy or sell. This prioritizes price control and may reduce spread-related costs, but execution is not guaranteed.
Stop order: A stop order becomes active only after a specified price is reached. Once triggered, it typically converts into a market order and is subject to prevailing bid-ask prices at that moment.
Buy-stop order: Placed above the current market price, often used to enter a position after upward momentum is confirmed.
Sell-stop order: Placed below the current market price, commonly used to limit potential losses or protect gains.

Understanding how these order types interact with the bid-ask spread helps investors manage both execution quality and trading costs, particularly in securities with wider spreads or lower liquidity.

Bottom Line

The bid-ask spread reflects how prices are formed when buyers and sellers interact in financial markets. It captures differences in supply and demand, trading activity and the willingness of market makers to provide liquidity while managing risk. Spreads are typically smaller in actively traded securities and wider when trading is limited or prices are moving quickly. For investors, the spread influences execution prices and trading costs, especially when entering and exiting positions over short periods.

Tips When Trading Securities

Even if you like to trade securities on your, a financial advisor can still help. For example, an advisor may be able to create a comprehensive financial plan that accounts for your investments, insurance needs and retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Liquidity affects how easily you can enter and exit a position at predictable prices. Securities with higher trading volume and narrower bid-ask spreads typically reduce transaction costs and limit the risk of slippage, especially during volatile markets. Thinly traded securities may look attractive on paper, but they can be harder to trade efficiently when timing matters.