When you look up a stock price in the paper or on a financial website, you only get one price -- the last price at which the stock traded. When you start to buy and sell stock for yourself, you notice two prices -- a bid price and an ask price. Depending on several factors, the two prices can affect your investment returns.
Participants and market makers are always entering prices at which they are willing to buy or sell stocks in the world's markets. The best available submitted price to buy a stock is called the bid price. The best available price at which a market participant has entered an order to sell is called the ask price. A difference always exists between the current bid and ask prices, because if they were the same, the order would be filled and the next-best offered prices would become the current bid and ask.
Buying and Selling
If you place a regular order -- called a market order -- to buy or sell stock through your stockbroker, the order will be filled at the ask price if you are buying and the bid price if you are selling. The ask price is what someone is willing to sell for; if you are a buyer, you pay the ask price. A bid price is what someone is willing to pay if you are selling. When you place the order through an online brokerage account, the order screen will show both the bid and ask prices before you place the order. Your market order should fill at or very close to the appropriate posted price.
The difference between the bid and ask prices is called the bid/ask spread. With coveted, actively traded stocks, the spread will be just a penny or two. For stocks that are not as heavily traded, the spread will start to widen. Exchange listed stocks may see spreads in the 5 to 10 cent range. With over-the-counter stocks, the spreads are often much wider, and spreads of 50 cents or more are not uncommon. The bid/ask spreads on stock may widen near the end of the market day as orders are taken off the board or there is short-term uncertainty about a particular stock.
Cost of Investing
The bid/ask spread is an additional cost of buying or trading stocks on top of the commissions charged by your broker. Since you buy at the higher ask price, you would have a loss equal to the spread if you sold right away and the stock price had not changed. The stock must rise by the amount of the spread before you are at break-even -- not including commissions -- on a stock purchase. If you plan to trade actively, consider sticking with stocks where the spread stays at a penny most of the time.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.