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Making Your First Trade

Bid-Ask Spread and Slippage

Pomegra Learn

Bid-Ask Spread and Slippage

The bid-ask spread is the gap between the highest price someone is willing to pay (the bid) and the lowest price someone is willing to sell (the ask). When you place a market order to buy, you pay the ask. When you place a market order to sell, you get the bid. The difference is slippage—an invisible cost extracted from every market order. For liquid index ETFs, this cost is trivial (1–3 cents per share). For illiquid stocks, it can be 50 cents or more per share.

Key takeaways​

  • The bid-ask spread is paid by every buyer (who hits the ask) and every seller (who hits the bid).
  • For liquid ETFs during regular hours, spreads are 2–5 cents. For illiquid stocks, spreads can be 50 cents to $2 or more.
  • Spread width depends on liquidity, volatility, and time of day. Spreads widen before earnings, during earnings crashes, and outside regular hours.
  • A spread that seems tiny per share (2 cents) accumulates: 2 cents × 10,000 shares = $200 cost per trade.
  • Market makers pocket the spread as compensation for providing liquidity. This is neither nefarious nor free.

The Economics of the Bid-Ask Spread​

Imagine VTI is trading at $240. The bid is $240.50 and the ask is $240.52. A buyer places a market buy order and hits the ask at $240.52. A seller places a market sell order and hits the bid at $240.50. The 2-cent difference ($240.52 − $240.50) is the spread.

Who pockets that 2 cents? The market maker who provided both sides of the trade. The market maker is the entity (usually an automated trading firm) that stands ready to buy or sell at known prices. When you buy VTI at $240.52 and someone else sells VTI at $240.50 to the same market maker, the market maker earns 2 cents on the round-trip.

This might sound unfair, but it's the payment for liquidity. The market maker provides an essential service: they're always available to trade, taking on inventory risk and price risk. If nobody was willing to be the market maker, you'd have to wait for another retail investor to show up wanting the opposite trade. The bid-ask spread is how the market maker gets paid.

For liquid securities, competition among market makers keeps spreads tight. VTI has hundreds of millions in daily volume and dozens of market makers competing. They keep spreads at 2–3 cents because if one market maker's spread is 4 cents, another will quote 3 cents and steal the business.

For illiquid securities, spreads are wider because there's less competition and more risk. A penny stock might have a 10-cent spread (bid $2.50, ask $2.60) because there's only one market maker willing to trade it, and it's risky.

How Spreads Vary by Security​

Different securities have different spread widths because of liquidity differences.

VTI (Vanguard Total Stock Market ETF): This is one of the most liquid ETFs in the world. Daily volume is 50–100 million shares. Spread is typically 2–3 cents.

SPY (SPDR S&P 500 ETF Trust): Similar to VTI, extremely liquid. Daily volume 50–100 million shares. Spread is typically 1 cent.

VEA (Vanguard FTSE Developed Markets Index ETF): Still very liquid, but less than VTI. Daily volume 20–40 million shares. Spread is typically 3–5 cents.

VXUS (Vanguard FTSE All-World Index ETF): High volume but internationally diversified, so more volatility. Daily volume 30–50 million shares. Spread is typically 3–5 cents.

Small-cap index fund (VB or IWM): Lower volume than large-cap funds. Daily volume 10–20 million shares. Spread is typically 5–10 cents.

Individual stock (Apple, MSFT, etc.): Very high volume (billions of shares daily) but more individual-stock volatility. Spreads are typically 1–2 cents for mega-cap stocks, 5–10 cents for mid-cap stocks.

Illiquid individual stock (micro-cap, delisted): Very low volume. Spread can be 50 cents to $5 or more. Sometimes the bid-ask is so wide that there's no real market—the spread is just a placeholder.

Bond ETF (BND, VBTLX): Lower volume than stock ETFs. Spreads are typically 2–5 cents. But there's more volatility, so sometimes spreads widen.

Spread Changes Throughout the Day​

A spread isn't constant. It widens and narrows based on market conditions.

Market open (9:30 a.m. ET): VTI spread might be 3–5 cents (wide, uncertain).

Mid-morning (10:30 a.m. ET): VTI spread narrows to 2 cents (liquidity has settled).

Midday (1:00 p.m. ET): VTI spread is still 2 cents (peak liquidity).

Afternoon (3:00 p.m. ET): VTI spread is still 2 cents.

Near close (3:50 p.m. ET): VTI spread widens slightly to 2–3 cents as traders prepare to exit.

After hours (4:30 p.m. ET): VTI spread might be 10–20 cents (liquidity has collapsed).

Pre-market (8:00 a.m. ET): VTI spread might be 5–10 cents (very few traders).

This is why trading during core hours (10 a.m.–3 p.m. ET) is advantageous: spreads are tightest.

How to See the Spread​

Your broker's trading platform should show you the bid and ask in real-time. Look for:

  • Bid: The highest price someone is willing to pay.
  • Ask (also called "offer"): The lowest price someone is willing to sell.
  • Bid-ask spread: Ask − Bid. Usually shown in the platform or you can calculate it.

Example on VTI:

  • Bid: $240.50
  • Ask: $240.52
  • Spread: $0.02 (2 cents)

Some platforms also show the bid size and ask size:

  • Bid: $240.50 × 10,000 shares (someone wants to buy 10,000 at that price).
  • Ask: $240.52 × 5,000 shares (someone wants to sell 5,000 at that price).

The sizes matter. If the ask size is very small (100 shares) and you want to buy 1,000 shares, your order might need to go to the next ask level (say, $240.53) to get all 1,000 shares filled. This is called "going through the book" or "moving through the stack."

Real-World Example: Accumulating Spread Costs​

Let's say you dollar-cost average $5,000 per month into VTI for 10 years (120 trades). VTI is averaging $240 per share over that period.

Each $5,000 purchase is about 20 shares ($5,000 ÷ $240). The bid-ask spread is 2 cents.

Cost per trade: 20 shares × $0.02 = $0.40.

Total cost over 10 years: 120 trades × $0.40 = $48.

$48 doesn't sound like much. But now let's say you're a more active trader and you dollar-cost average $10,000 per month (200 trades over 10 years).

Cost per trade: 40 shares × $0.02 = $0.80.

Total cost over 10 years: 200 trades × $0.80 = $160.

Now imagine you're trading a less liquid security. A micro-cap stock with a 50-cent spread.

Cost per trade: 20 shares × $0.50 = $10.

Total cost over 10 years: 200 trades × $10 = $2,000.

The $2,000 in spread costs is a real drag on returns. If you're earning 7% annual returns, that $2,000 in lost capital compounds to over $20,000 in missed growth over the next 10 years.

This is why buying and holding liquid index funds is so powerful: low spreads compound the advantage.

Spread, Slippage, and Execution Quality​

The spread is the theoretical cost. The actual cost to you might be different, depending on execution quality.

Best case: You pay the ask (for a buy) and the slippage equals the spread. VTI bid $240.50, ask $240.52, you buy at $240.52. Slippage is 2 cents.

Good case: You pay somewhere between the bid and ask (a better price than the ask). This can happen if there's a partial fill at the ask and a partial fill at a better price. Slippage is less than the spread.

Mediocre case: You pay worse than the ask because the market moved while your order was being routed. The ask was $240.52, but by the time your order hit the exchange, the ask is $240.55 (the stock rose). You pay $240.55. Slippage is 5 cents.

Worst case: You get filled at a terrible price because of a trading halt, a liquidity crisis, or a broker error. You meant to buy at $240 and somehow your order fills at $250. This is rare but possible during market crashes or technical failures.

For retail investors buying liquid ETFs with major brokers, you'll be in the "best case" or "good case" most of the time. The slippage you experience will be close to the bid-ask spread you see.

Strategies to Minimize Spread Cost​

  1. Trade during peak hours (10 a.m.–3 p.m. ET): Spreads are tightest when liquidity is deepest.

  2. Trade liquid securities: Buy VTI, not a micro-cap penny stock. The 2-cent spread on VTI is cheaper than the $1 spread on a micro-cap.

  3. Avoid trading before earnings or major events: Spreads widen sharply before uncertainty (earnings, Fed announcements). If the event is tomorrow, wait until after the event.

  4. Use limit orders for very tight control (but accept the risk of non-execution): If you're willing to wait, a limit order at the midpoint (bid + ask) / 2 might fill and save you half the spread.

  5. Dollar-cost average to reduce timing luck: If you trade every week instead of every month, you average out the luck of whether you trade on a narrow-spread day or wide-spread day.

  6. Don't obsess over pennies: A 2-cent spread on a $240 stock is 0.008%. Your ability to pick good investments and stick with them for decades matters infinitely more than optimizing spread costs.

Spread and Slippage Timeline​

Next​

Most spreads you'll encounter happen during regular market hours. But what if you want to trade before the market opens or after it closes? Pre-market and after-hours trading promise the ability to react to overnight news. The final article in this chapter explores why that promise comes at a steep cost.