What is bid ask spread: Meaning, Significance & Effect on Trading Costs.

Key Insights 

1. Spreads are hidden costs. The difference between buying and selling prices means you start each trade with a small loss. Choosing stocks with smaller spreads helps you save money.
    
2. Liquid large-caps (like Reliance) have tiny spreads (₹0.30-₹1), while unknown stocks cost more (₹5+).
    
3. Trade at peak hours (11 AM-2 PM) and avoid panic periods to get the best prices and lowest costs.

The bid-ask spread is the difference between the price at which buyers are willing to buy and the price at which sellers are willing to sell. It gives you an idea of how easy or difficult it is to sell something and how much it is going to cost.

Example:

Deepak wants to sell his old bike; buyers offer up to ₹50,000 (bid price). Deepak asks for at least ₹55,000 (ask price). The bid-ask spread is ₹5,000 (₹55,000 – ₹50,000).

Here’s a simple table explaining the terms:

This table explains key trading terms, bid, ask, and spread, using the example of Deepak selling his bike.
 

The ₹5,000 spread represents the transaction cost; Deepak negotiates to bridge this gap for a successful sale.

This blog helps you learn how bid-ask spreads work in merchant payments. It is all about price making when buying and selling. Further in the article, you will see how bid-ask spreads happen inside the stock market with an example.

Bonus Tip: Low liquidity, volatility, or off-peak trading can widen spreads. Avoid small-caps or volatile markets to save costs.

Why Does Bid-Ask Spread Matter?

Bid-ask spread refers to the price gap between the offer and demand of a stock given by both buyers and sellers. It is essential as it will determine your trading expenses and the ease of purchasing or selling shares.

Why It’s Important for Traders Like Sharma Ji:

This table explains how the bid-ask spread affects trading costs, liquidity, and overall profitability for investors like Sharma Ji.

1. Trading Cost
   • Every time Sharma Ji buys or sells, he pays the spread.
   • A bigger spread means higher costs, eating into profits.
      
2. Liquidity Check
   • A small spread means the stock is easy to trade (many buyers/sellers).
   • A large spread means fewer traders, making it harder to exit quickly.
      
3. Impact on Profits
   • If Sharma Ji buys at the ask price and sells at the bid price, he loses the spread amount.
      

A smaller spread reduces trading costs and improves liquidity, making it easier to enter and exit positions without significant profit loss.

Table: Sharma Ji Trades SBI Shares
 

This table shows the bid-ask spread for a stock, highlighting the small but important difference between what buyers offer and sellers demand.
 

The ₹2 per share spread represents the immediate cost of trading, buyers pay slightly more than sellers receive, impacting short-term profits.

• If Sharma Ji buys 100 shares:
  • He pays ₹60,200 (₹602 x 100) instead of ₹60,000.
  • To break even, the stock must rise above ₹602.
     
• If the spread was ₹5 (illiquid stock):
  • He’d need the stock to rise more just to cover the extra ₹500 loss.

Key Takeaways:
 

This table explains how the bid-ask spread impacts trading efficiency and costs for investors like Sharma Ji.
 

• A small spread (₹1-₹2) = Good for trading.
   
• A big spread (₹5+) = Higher costs, harder to trade.
   
• Sharma Ji should stick to liquid stocks to save money.
   

Choosing stocks with small spreads (₹1-₹2) reduces trading costs and improves liquidity, making it easier to enter and exit positions profitably.
 

This is why the knowledge of bid-ask spread can assist traders in their decision-making.

Bonus Tip: Trade liquid stocks (e.g., large-caps) during peak hours (11 AM-2 PM) and use limit orders to control prices.

How Does Bid-Ask Spread Affect Trading Cost?

The difference between a stock's buying and selling prices is known as the bid-ask spread. While a smaller spread saves money, a larger spread means higher trading expenses.

How It Impacts Rakesh’s ₹2,00,000 Trade

This table highlights the immediate financial impact of bid-ask spreads on traders like Rakesh during buying and selling.
 

1. Buying Costs More
   • Rakesh must pay the higher "ask" price when buying.
      
2. Selling Pays Less
   • He receives the lower "bid" price when selling.
      
3. Instant Loss
   • The difference is lost immediately in each trade.
      

The spread represents an unavoidable cost, traders instantly lose the difference between the higher buy price and lower sell price with each transaction.

Table: Suppose Rakesh Trades ITC Shares
 

This table illustrates the immediate per-share loss a trader incurs due to the bid-ask spread when buying and selling a stock.
 

The ₹2 difference between the purchase (demand) and sale (supply) price represents the hidden cost of trading, emphasizing the need to account for spreads in profit calculations.

Trade Details:
 

• Rakesh invests ₹2,00,000 in ITC at ₹430 per share (he bought 465 shares)
   
• If he sells immediately at ₹428:
  • Receives ₹1,99,020 (₹428 × 465)
  • Loses ₹980 due to the spread

Worse with Illiquid Stocks:
 

This table compares the trading costs (spread impact) between large-cap and small-cap stocks for a ₹2,00,000 investment.
 

Small-cap stocks incur nearly 5x higher trading costs due to wider spreads, highlighting the importance of liquidity in minimizing losses.

Key Takeaways:
 

This explains how the bid-ask spread directly impacts trading costs and profitability, especially for large transactions.
 

• Every trade starts with a loss equal to the spread.
   
• Liquid stocks (₹1-2 spread) cost less to trade.
   
• Illiquid stocks (₹5+ spread) eat our profits faster.
   
• Rakesh should check spreads before trading large amounts.
   

To maximize returns, traders like Rakesh should prioritize liquid stocks with narrow spreads (₹1-2) to minimize initial losses and protect profits.
 

Spread analysis is essential for successful trading because of this hidden expense.

Factors Affecting Bid-Ask Spread

The simple nature of trading a stock (liquidity) and the amount of price volatility (volatility) affect the bid-ask spread. These factors decide whether the spread is small or large.

How Liquidity & Volatility Affect Aman's Trades:

1. Market Liquidity (Easy to Buy/Sell?)
   • More buyers/sellers = Smaller spread
   • Fewer buyers/sellers = Bigger spread
      
2. Price Volatility (Big Price Swings?)
   • Stable price = Smaller spread
   • Wild price changes = Bigger spread

Example: Aman Trades Two Stocks
 

This table compares the bid-ask spreads of a popular large-cap stock and an unknown small-cap stock, showing how liquidity affects trading costs.
 

The small-cap stock’s wider spread (₹1.30) leads to higher immediate losses per trade, emphasizing the importance of liquidity for cost-efficient trading.

What This Means for Aman:
 

• Large-Cap Stock (₹500):
  • Tight ₹0.30 spread
  • Costs just ₹30 extra on 100 shares
     
• Small-Cap Stock (₹50):
  • Wide ₹1.30 spread
  • Costs ₹130 extra on 100 shares

Key Factors in Simple Terms:
 

This table explains how factors like trading volume, company size, market conditions, and time of day influence bid-ask spreads in stock trading.
 

Spreads widen (become costlier) during low liquidity, panic, or off-peak hours, emphasizing the need for traders to time trades and choose stocks wisely to minimize costs.

Aman's Lesson:
 

This table summarises practical strategies to minimise trading costs by optimising stock selection and timing based on spread behaviour.
 

• Stick to popular stocks during busy hours for the smallest spreads.
   
• Avoid unknown stocks when markets are jumpy.
   
• Always check the spread before trading.

By focusing on liquid stocks during peak hours and avoiding volatile conditions, traders can significantly reduce spread-related losses and protect their profits.

This helps Aman save money on every trade he makes.

How to Minimise Bid-Ask Spread Costs
 

Minimising bid-ask spread costs is crucial for traders to preserve profits and enhance returns. Here’s how to do it:

Key Strategies:
 

1. Trade Liquid Stocks: Choose high-volume large-caps (e.g., Reliance) with narrow spreads (₹0.30-₹1).
    
2. Timing Matters: Trade during peak hours (11 AM-2 PM) when market activity is tight, spreads are narrower.
    
3. Avoid Volatility: Avoid small-caps or panic-driven markets where spreads widen (₹5+).
    
4. Use Limit Orders: Set buy or sell prices to avoid paying the full spread.
    
5. Check Spreads Pre-Trade: Always verify the spread size before executing large orders.

By prioritising liquidity, timing, and smart order types, traders can drastically reduce spread costs and maximise net gains.

Conclusion 
 

Understanding the bid-ask spread helps you recognize the hidden costs of stock trading. As Aman found, popular stocks with high trading volume typically have smaller spreads, making them more cost-effective to trade.
 

In contrast, less popular stocks or volatile markets often have larger spreads, which can reduce your returns. By monitoring spreads and choosing your trades carefully, you can save money on each transaction.
​

Tracking the bid-ask spread helps you make informed trading decisions and retain more of your earnings, regardless of experience. Even small savings on each trade can add up over time.

FAQs

How can I avoid paying big spreads?

Stick to well-known stocks, trade during busy hours, and use limit orders (where you set your price) instead of market orders.

Is widespread always bad?

Not always: if you're holding long-term, it matters less. But for frequent traders, wide spreads eat profits fast.

Why do some stocks suddenly get wide spreads?

Bad news, low trading volume, or market crashes can scare buyers/sellers away, making spreads balloon.

Do big investors pay the same spreads?

No, institutional traders get better rates. Retail traders (like us) always pay the public spread, which is why it’s costlier for small investors.

Where can I check the spread before trading?

Your trading app shows live bid-ask prices. Always look at them before placing an order to know the real cost.

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