What is the Bid-Ask Spread? Definition, Formula, and Example
The bid-ask spread is the difference between the highest price buyers will pay and the lowest price sellers will accept, representing the implicit transaction cost of trading and the primary measure of market liquidity.
Definition
The bid-ask spread is the difference between the highest price a buyer is willing to pay (the bid) and the lowest price a seller will accept (the ask) for a security at a given moment. It represents the implicit transaction cost of crossing the market — buying at the ask or selling at the bid — and serves as the primary measure of a market's liquidity. Tight spreads indicate liquid, competitive markets with many participants; wide spreads signal illiquidity, uncertainty, or elevated risk that market makers are pricing in.
How the Spread Is Calculated
Absolute spread = Ask − Bid
Percentage spread = (Ask − Bid) / Midpoint × 100
Where the midpoint equals (Ask + Bid) / 2. Percentage spread is the meaningful comparison across securities at different price levels. A $0.05 spread on a $5 stock (100 basis points) is far more expensive than a $0.05 spread on a $500 stock (1 basis point).
Market makers profit by continuously buying at the bid and selling at the ask, capturing the spread as compensation for providing liquidity and bearing inventory risk. They widen spreads when volatility rises, news is pending, or they accumulate unwanted inventory.
Worked Example
SPY, the most liquid U.S. equity instrument, trades with a one-cent spread during regular hours:
- Bid: $558.42
- Ask: $558.43
- Absolute spread: $0.01
- Percentage spread: 0.18 basis points
AAPL typically quotes:
- Bid: $241.12
- Ask: $241.14
- Absolute spread: $0.02
- Percentage spread: 0.83 basis points
Compare to a small-cap biotech trading $8.50 × $8.75: a 25-cent spread is 290 basis points — nearly 3% round-trip. A trader needs a 3% move just to break even, before commissions. Options spreads run wider still. An AAPL weekly call might show $2.10 bid × $2.20 ask — a 4.7% spread against the midpoint.
When Traders Use It
Spread analysis drives execution strategy. Active traders place limit orders inside the spread when liquidity is sufficient, paying only a portion of the spread rather than crossing it entirely. Algorithmic traders monitor effective spread — the difference between the execution price and the midpoint at the time of arrival — as their primary execution-quality metric.
For position sizing, the spread caps realistic scalp profits: if a pair strategy's edge is 5 basis points but the round-trip spread cost is 10 basis points, the strategy is unprofitable by construction. In options, wide spreads routinely destroy theoretically profitable edge in complex multi-leg strategies.
Market-making firms like Citadel Securities, Virtu, and Susquehanna have built their entire business on capturing spreads across billions of daily shares.
Limitations and Common Misconceptions
The displayed spread — the National Best Bid and Offer, or NBBO — does not reflect total available liquidity. Dark pools, hidden orders, and midpoint venues offer execution inside the displayed spread for sophisticated order flow. Retail brokers commonly route orders to wholesalers who provide price improvement — execution at prices better than the displayed NBBO — through payment-for-order-flow arrangements.
Spreads widen dramatically at the open, the close, during news events, and in low-volume pre/post-market sessions. A ticker that trades at a 1-cent spread at noon may show 20-cent spreads at 4:15 PM.
Finally, tight spreads do not guarantee execution at the quoted price when trading size. Sweeping the book for 10,000 shares may walk the price several cents beyond the displayed ask — a phenomenon called market impact, distinct from but related to the spread.