How Does Bid & Ask Work in Stock Trading?
The bid price is the highest price a buyer is willing to pay for a share of stock, and the ask price is the minimum the seller is willing to accept. The ask price is usually higher than the bid price. The difference between the bid and ask prices is the bid-ask spread, which narrows or widens depending on the trading volume. Stock exchanges typically use automated systems to match the bid and ask prices and fill orders.
The basic order types are market and limit orders. Buy and sell market orders are filled at the best available ask and bid prices, respectively. For example, if you enter an order to buy 100 shares at market and the best available ask is $10, you will pay $1,000 plus commissions to fill your order. Buy and sell limit orders are filled only if there is a sufficient quantity of shares available at the specified ask and bid prices, respectively. Stop orders become market orders at the specified stop price. Stop-limit orders are limit orders at the specified stop price and are executed at the limit price.
Thinly Traded Stocks
Some stocks, such as those with a small number of outstanding shares, do not trade in large volumes. These thinly traded stocks usually have large bid-ask spreads. You should never place a market order for a thinly traded stock because your order could be filled at a price that is significantly different from what you had expected. Place limit orders to ensure that your order is filled only at a specified price, even if it means that your order might not be filled.
Markets may move up or down by a percent or more during a single trading session, sometimes within minutes. Bid and ask prices change frequently in this environment. To avoid a fill at the wrong price, place limit orders and monitor the order status closely. For example, if you place a market buy order for a stock when it is at $10, your order could be filled at $12 or more in a rapidly rising market. While this might turn out to be a profitable trade if the price continues to rise, a sharp reversal could bring the share price down to $10 by the end of the trading session.
The bid-ask spreads tend to be wider in the extended-hours trading sessions, which are available on several exchanges. These sessions have fewer participants, which means less volume and wider spreads. Place limit orders during these sessions because market orders could be filled at unfavorable prices. Bid-ask prices during the extended hours may not reflect prices during regular trading sessions.
Based in Ottawa, Canada, Chirantan Basu has been writing since 1995. His work has appeared in various publications and he has performed financial editing at a Wall Street firm. Basu holds a Bachelor of Engineering from Memorial University of Newfoundland, a Master of Business Administration from the University of Ottawa and holds the Canadian Investment Manager designation from the Canadian Securities Institute.