Bid-Ask Spread — Simplified

Let’s start simple; if you walk into a market tomorrow to buy a bicycle for your child, what thoughts do you have about the price? well, you sure want it to be cheap. you want to buy the best bicycle possible for the cheapest price. In finance, this price you have in mind to buy this bicycle is called the ‘Bid’.

let’s forget you for a moment. let’s consider the seller’s perspective. for them, they want to make the highest possible profit on this bicycle by any means possible. they want to increase this price juuust enough to get you to still buy the bicycle. this price in the mind of the seller is called the ‘Ask’

some scratch drawing:

But then, you are not the only buyer in this market. there are other buyers too and there are other sellers as well. I mean, wouldn’t it be just boring for there to be only one buyer and one seller? so let's redraw.

Now that you have a visual and intuitive idea of all of these concepts, formally, bid-ask spread is the difference between the maximum bid and the minimum asking price at any time in the market. you can clearly see from the diagram where this difference is.

Bonus:

if the bid-ask spread is large then the buyers and sellers are not agreeing easily on a price therefor we say that market is not liquid. if the spread is very small then they are coming quickly to a price agreement and hence the market is liquid.

Still want some formulars? here you go: