Bid-Ask Spread Explained with an Example

The bid-ask spread is the difference between the highest price a buyer will pay (the bid) and the lowest price a seller will accept (the ask). It is the most basic cost of trading: you pay the ask when buying, receive the bid when selling, and pocket nothing when the spread exceeds your profit. Understanding bid-ask spreads is essential because they drain returns silently—far more than most individual investors realize.

A Worked Example

Imagine Apple stock trades with a bid of $195.47 and an ask of $195.50. The spread is $0.03 per share, or 1.5 basis points.

You decide to buy 100 shares. You must hit the ask: you pay $195.50 × 100 = $19,550.

A few hours later, you change your mind and sell. The best bid is now $195.48. You receive $195.48 × 100 = $19,548. Your round-trip cost: $2, or about 0.01 percent of your trade value.

This seems trivial for large-cap stocks. But now imagine a smaller technology firm trading 50,000 shares per day. Its bid might be $42.05 and its ask $42.20—a 15-cent spread, or 36 basis points. Buy 200 shares at the ask ($8,440), and sell them an hour later at the bid ($8,410). You’ve lost $30, or 0.35 percent, without any underlying stock movement.

Multiply this across dozens of trades per year and the cumulative drag becomes significant.

Why Spreads Exist

Spreads are the market maker’s profit. A market maker—a dealer or exchange specialist—stands ready to buy from sellers and sell to buyers continuously. They make money on the spread between what they pay and what they receive.

This is not corruption. It is compensation for three things:

1. Inventory risk: The market maker holds shares and faces price risk until they sell to the next buyer
2. Adverse selection: A seller rushing to exit might have bad news; a buyer eager to accumulate might know something good. The spread protects against trading against the informed
3. Operating cost: Running a trading operation is expensive; the spread funds staff, technology, and rent

What Widens or Narrows Spreads

Spreads are tightest in the most liquid, widely followed securities:

• S&P 500 large-cap stocks: Spreads often a penny or less (1–5 basis points)
• High-volume blue chips: Apple, Microsoft, Tesla trade in tight spreads
• Liquid ETFs: Major equity indices and bond funds may have sub-basis-point spreads

Spreads widen dramatically when:

• Volume drops: After hours or on holidays, spreads blow out to several cents even for mega-cap stocks
• Volatility spikes: During market downturns, credit events, or earnings shocks, dealers widen protection
• Liquidity is thin: Small-cap stocks, illiquid bonds, or thinly traded emerging-market securities may have spreads of 1 percent or more
• Broken news: Rumors or halts cause spreads to explode as dealers refuse to trade at normal rates

During the 2008 financial crisis, spreads on U.S. Treasury bonds—typically measured in millionths of a percent—widened to several cents. A portfolio manager selling bonds faced massive implicit costs even in “safe” securities.

Spread as a Hidden Fee

For active traders, spreads accumulate fast. A day trader executing 20 trades at an average 5-basis-point spread on $10,000 positions burns 10 basis points of capital per day—100 basis points per working month. Over a year, that’s roughly the full return of bonds or the inflation rate, gone before the trader even earns a profit.

This is why passive index-fund investors have an edge over high-turnover traders. Index funds trade infrequently (rebalancing a few times per year), so spread costs remain negligible. Active traders and funds pay spreads constantly; index-tracking vehicles pay them rarely.

Bid-Ask Spreads Across Asset Classes

Different markets have different spread structures:

Corporate bonds are especially opaque. A bond trade might show a 30 or 50-basis-point spread even in “investment-grade” debt, and the seller often has no way to know the true market spread—the dealer quotes what they quote.

The Bid-Ask Spread vs. Commissions

Modern brokers often advertise “zero commission” trading, but spreads remain. In fact, eliminating commissions can worsen spreads because dealers compensate by widening the spread. You pay either way—just less visibly through spread.

A zero-commission broker executing a trade for you at a 10-basis-point worse spread than a commission-based competitor has cost you more, not less.

See also