Tips for using Bid-Ask Spreads
I recently have been looking at the Bid-Ask Spread (sometimes called the Bid-Offer Spread) to help me determine the right time to add to my positions. Here are some tips I’ve picked up that you might find useful when looking at your stock’s spread.
1. Understand the Numbers
There are four pieces of information that make up the spread info. Find them, know them, love them:
- The Bid Price. This is the amount you will pay to buy the stock right now.
- The Ask or Offer Price. This is the amount you will receive to sell the stock right now.
- Bid x Ask Shares. This is the number of shares requested for purchase versus the number of shares available for sale.
- Volume. The number of shares traded from the beginning of the session to the time of the quote.
2. Check the number of bidding and asking shares.
If you see something like 5.0 x 3.0 for the bid x ask shares, there could be a potential rally as the number of shares requested for sale is exceeding the number of shares available to purchase. This constrained supply may increase the share price.
Conversely, if the bid x ask shares are showing up as 2.0 x 4.0, there are more shares available to purchase than there are to buyers. This surplus in supply could lead to falling prices.
3. On the NYSE, Check it Real-time.
The NYSE bans the publication of bid-ask spreads on delayed quoting services, so if you want to see what the spread is, log in to your brokerage account and get a real-time quote.
Wrapping it Up
The bid-ask spread is important for those who are looking to maximizing their returns by timing their entries, and also can provide useful indicators when a stock is about to turn around. I encourage you to read over the excellent articles below to better understand how the spread works.
Resources
Trading - Bid, Offer and Spread. by Chris Lott. The Investor FAQ.
Why the Bid-Ask Spread is so Important. Investopedia.
What are the determinants of a stock’s bid-ask spread? Investopedia.
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Great blog. People often neglect the importance of the bid ask spread when trading in and out of positions that are less liquid. Though most stocks people look at tend to have a tight bid ask spread, the spreads on less liquid instruments (like options or smaller volume stocks) tends to take a fair bite out of your profit potential.
http://mmmlife.com/2006/08/puts-and-calls-a-basic-options-primer/
Sounds nice, but it’s flawed and I would not use it. I know for a fact that my broker has something called iceberg orders. Essentially what that means is that when I submit my order only a percentage of my order shows up on the bid ask tables. However, when my execution goes through the entire “iceberg” is recorded. So I could submit an order of 10000 shares, but have only 100 show up on the bid-ask table.
I asked about this with my broker and they said it is common to use and only the volume is 100% correct and cannot be “tricked”.
I have to agree with Christian. There are a LOT of games people play with bid/ask and Level 2. Don’t really expect people to show their true hands in the order book! Unless you’re a scalper I wouldn’t even bother trying to game the spread.
How are the bid/ask volumes worked like that? Is there some place you can enter in the volume you’d like to show up?
[...] Tips For Using Bid-Ask Spreads, from Chris Welch of InvestorGeeks and he dives into bid/ask spreads and learns how to use them to your advantage. [...]
You need a broker who supports it. If your broker does support it, then you can enter what you would like to show up.
There are other tricks that brokers can play:
1) Hidden so that you order does not show up in the books at all
2) Scaled so that your order shows a decreasing amount. Eg let’s say that you want to buy at 10.20, but to show the negative you create a series of orders at 10.20, 10.19, 10.18, etc. Thus it seems like there are number of low priced orders, when in fact you are more than willing to pay 10.20.
3) Iceberg which only shows a percentage.
As was commented. There are so many tricks that professional traders play with the books that I would not rely on the bid ask price spread.
I personally don’t play these tricks because, well, I don’t play in those share count levels 5000> per order. And what should be noted here is that it is the big players that actually move the market that are playing these tricks.
Excellent. Thanks for all your great info, Christian and Mike.
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