Unlike most things you buy, both the buyer and seller set stock prices. The buyer states what price they will pay for the stock – this is the bid price.
The seller also has a price – the ask price.
It is the role of the stock exchanges and the whole broker/specialist system to facilitate the coordinating of the bid and ask prices. However, this service doesn’t come without a price.
The Bid/Ask Pricing
If you have access to the proper online pricing systems, you can see the bid and ask prices. The Nasdaq structures its pricing around the bid-ask.You will notice that the bid price and the ask price are never the same. The ask price is always a little higher than the bid price.
What this means is if you are buying the stock you pay the ask price (the higher price) and if you are selling the stock you receive the bid price (the lower price).
The Bid/Ask Spread
What happens to the difference between the two prices? This difference is the spread and it is kept as profit by the broker/specialist handling the transaction. In truth, the spread goes to pay a number of fees in addition to the broker’s commission. Note: This is not the same commission you pay a retail broker.Because prices move constantly, especially for actively traded stocks, you can’t know what price you will get if you are a buyer or a seller unless you use specific market orders. See my article on market orders.
Conclusion
There are ways around the bid/ask spread, but most investors are better off sticking with the established system that works well, even if it does take a little ding out of your profit.Other Articles in This Series
Understanding Bid & Ask Prices
Using Trailing Stops to Protect Stock Profits
Understanding Stop Loss Orders
Market Specialists Make NYSE Work
