Bid-ask spread
What is Bid-ask spread?
The bid-ask spread is the difference between the best available buying and selling quotations for an asset at a given moment.
Portfolio dashboards should label whether a spread is current, delayed, sampled, or estimated. Aggregating observations across holdings is most meaningful when weighted by intended trade value, since a simple average lets many tiny positions dominate the displayed liquidity assessment.
How it is measured
The quoted spread equals ask minus bid and can be expressed in currency, basis points, or as a percentage of midpoint. The effective spread compares an execution with the prevailing midpoint and can reveal price improvement. Realized spread and price impact examine later prices. These measures answer different questions and require synchronized, high-quality quote and trade data.
Why spreads differ
Spreads compensate liquidity providers for order-processing cost, inventory risk, adverse selection, capital, and uncertainty. They often widen when volatility rises, information is asymmetric, trading is thin, or markets are closed elsewhere. Tick size can constrain the minimum displayed spread. Competition, transparency, electronic access, and natural two-sided flow can narrow it, though displayed size may also decline.
Example
A security bid at $20.00 and offered at $20.10 has a ten-cent quoted spread and a midpoint of $20.05. Buying at the ask and immediately selling at the unchanged bid loses ten cents per share before commissions. A purchase at $20.03 receives price improvement relative to the ask, but the full implementation cost still depends on subsequent price movement and size.
Portfolio relevance
Spread is a direct component of trading cost and can materially reduce returns for high-turnover or illiquid strategies. Fund net asset values based on midpoint may not reflect exit value. Capacity analysis should combine spreads with depth and market impact, especially during stress. Historical backtests need time-varying spreads rather than one current estimate applied across every market regime.
Practical checklist
Compare assets at the same time and normalize spread by price, but retain absolute cost for sizing. Inspect quote age, venue, lot size, market hours, and whether a trade occurred inside or outside the displayed market. Do not assume a narrow top-of-book spread means a large order is liquid, or that a wide indicative spread always becomes the executed cost.
Sources and further reading
- Trade Execution: What Every Investor Should Know, U.S. Securities and Exchange Commission