Every asset transaction has two sides: a buyer and a seller. Whether you are selling stocks or doing real estate transactions, two forces are always at work in determining the final price. Buyers want to pay as little as possible; sellers want to earn as much as possible. If you are the seller, you are the party that sets the asking price: the the lowest an owner is willing to sell an asset, like stocks.
That’s what starts the conversation: what attracts buyers and determines the bid. It will always be higher than the bid price, because no investor will willingly pay more than what a seller asks.
When you invest, you will encounter demands in each market, usually as part of a supply-demand gap. It is important to understand what the price represents and how it influences the price of the asset.
Asked price compared to the buyer’s price
As mentioned, it is opposed to the bid price in a transaction. A seller’s price is the lowest amount they are willing to accept, and if there is no buyer at that price, no transaction takes place. As the highest price a buyer is willing to pay, the ask price effectively sets the floor price for the asset.
When doing transactions directly with each other, for example through real estate, buyers and sellers need to come to an agreement. It means lowering the ask price and increasing the asking price until there is a compromise. When trading through exchanges, market makers serve to bridge the gap between the two, making it easier to trade. In either case, if you are the seller, the goal of the transaction is to agree on the highest possible price.
Investors are probably more familiar with this than they think. Yet recognizing the asking price in the context of different types of investing requires an understanding of what that means, in particular. Here are some examples on different assets.
- One share can have a demand of $ 50.69 x 100, which is 100 shares at $ 50.69 / each
- A property listed at $ 289,000 means the seller has set it as their desired selling price
- Forex is contextualized within a currency pair, such as EUR / USD 1.1250 / 1.1251
What is the Bid-Ask spread?
All the asset transaction occurs based on the bid-ask spread: a real-time bidirectional quotation system. The sellers send a request to the market and the buyers counter with an offer. The distance between the two is the spread. Investors pay when they buy a security and receive the offer when they sell, with market makers profiting from the difference.
- The smaller spread, the more liquid the asset. This means that buyers and sellers more easily agree on the price of a security. The lowest price that sellers will accept approximates the highest price a buyer is willing to pay.
- The bigger spread, the more risky the asset. This suggests that buyers and sellers disagree on the asset’s value and are less likely to agree on the price. As a result, the asset is less liquid.
Bid-ask spreads vary considerably between different investment vehicles. For example, a small-cap volatile growth stock may have a bid-ask spread that varies by several dollars, while blue-chip large-cap companies vary by only a few cents. In forex, bid-ask spreads span one or two pip, which is the smallest unit of price measurement.
For example, in November 2021 Plexus Corp. (NASDAQ: PLXS) had a bid-ask spread of $ 88.30 – $ 93.64. During this time, Johnson & johnson (NYSE: JNJ) had a bid-ask spread of $ 165.59 – $ 165.60. The companies have a market capitalization difference of about $ 430 billion.
Relationship with a bear market
When prices are too high, it can scare off investors. High prices tend to suggest that sellers highly value their titles and are more confident than potential buyers. Therefore, prices peak and start to drop. To restore liquidity, sellers must reduce their number, thus bringing it closer to buyers’ bids.
Securities and markets tend to go down until there is a balance between buyers and sellers. If this equilibrium is more than 20% of highs, it represents a bear market. Usually, this only happens when the sellers pull back. In this way, the markets remain self-regulated.
One side of a two-way quote
If you are selling an asset, you want to get the best price for it. So it makes sense to question for the best price. This is exactly what investors do when they sell securities. In a market where millions and millions of transactions take place daily, sellers set the price for every asset listed on the stock exchange. This attracts bidders, which keeps the markets moving. It is a real-time, two-way, self-contained quotation system that encompasses the free market.
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The next time you’re evaluating a potential investment, take a look at the current bid-ask spread. Pricing by sellers can say a lot about what to expect from that asset and how to approach its transaction.