Bid-Ask Spread
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The bid ask spread formula is the difference between the asking price and bid price of a particular investment. The bid ask spread may be used for various investments and is primarily used in investments that sell on an exchange.
Use of the Bid Ask Spread
The bid ask spread may be used to determine the liquidity of a particular investment. A higher trade volume, or higher liquidity, will generally lead to a lower bid-ask spread. One analogy could be comparing the difference in asking price and the offer price of a home or piece of art(not sold at an auction). These assets may take longer to sale and there may be less individuals looking to buy the individual's particular asset. On the other hand, stocks, commodity futures, currency exchanges and futures are often considered to be more liquid as many buyers and sellers trade on the market every day that the exchange is open.
The bid ask spread may also connote the costs involved with buying a particular investment when an intermediary holds and purchases the investment. For example, suppose that a specialist on an exchange will offer to sell and are also willing to purchase the same security. The gap between the price they're willing to sell at and the amount they will purchase the security for would be considered a profit for them and a theoretical cost for the other party.
Example of the Bid Ask Spread
Suppose that a particular stock is offered at $37.80 and the bid price is $37.75 is the bid price. The bid ask spread would be the .05 difference between the two investments. In order for a transaction to take place, an offer matching the bid price or a bid matching the offer price would need to match, which will in turn leave another gap to be in place.