Buying or selling shares can be truly overwhelming.
Pressing that green or red button throws out a whole flood of emotions which is hard to contain – either absolute glee (great profits) or remorse (losses that you feel could’ve been prevented). Whatever the emotion is, it’s always good to know the basics so that when you do press them you aren’t all emotional but can view it logically as well.
Market price – this is without a doubt the easiest thing to understand. Look at the price of the position you want to take and that’s what you’ll get. There is a little slippage at times, but we get over it quickly.
Bid price – What the Buyer wants to pay for the stock/equity (lower than ask price)
Ask price – what the Seller wants to get for the stock/equity (lower than bid price)
Bid/Ask Spread – the difference between what the buyer wants to pay and what the seller is willing to take.
Think of it this way – when traveling to a different country you head to the bank to exchange money. What do you see light up on a big exchange board behind the bank tellers’ heads? Two prices, right!
1. Dollars into local currency – you are buying the local currency – bid (buy)– you want to get the most amount of local money for each dollar you give them
2. Local currency into dollars – you are selling the local currency to get your dollars back – ask (sell)– you want to sell back the local money and get the most amount of dollars
You will get less local currency for when you buy it and it will cost you more local currency when you sell it back. This is just how it works. You can’t fight it. And the difference is the spread.
For example: Costa Rica currency
Buying local currency with Dollars (Bid)
500 Colones = $1
Selling Local Currency buying Dollars (Ask)
490 Colones = $1
Spread of the two
10 Colones for each dollar
So where does the money of the spread go?
It’s kept as a tasty profit for either the broker/banker/specialist in charge of the transaction. (NOTE: this is not commissions. If commissions apply is added on top.)
When there is a large spread, chances are the stock is traded too lightly and is not a good stock to invest in.
On a whole, the bid ask spread needs to be really small. If it’s too high, stay away until it shrinks.
This is as basic as it gets.