Bid, ask, spread and liquidity
Every position starts at a small loss. The size of that loss is a cost you control through timing and instrument choice.
9 min read · beginner · lesson 3 of 6
What this covers
- Read a two-sided quote
- Calculate the entry cost implied by a spread
- Explain how depth differs from spread
- Identify the conditions that widen spreads
- Account for slippage and market impact when sizing
The quote
- Bid
- The price at which you can sell. The higher of the two prices a market maker will pay.
- Ask
- The price at which you can buy. Always above the bid.
- Spread
- The difference between the two. The market maker's compensation for quoting continuously.
- Depth
- How much size rests at and near those prices. A tight spread on almost no size is not liquidity.
- Liquidity
- Spread and depth together: how much can transact at or near the current price without moving it.
What the spread costs
IllustrativeFigures below are illustrative and are not drawn from any current market.
A pair quoted 1.0850 bid and 1.0851 ask carries a one-pip spread. Buying at the ask puts the position immediately one pip below break-even, because closing means selling at the bid.
On a standard lot at ten dollars per pip, that is ten dollars per round trip. Trading that instrument twenty times a month costs two hundred dollars in spread alone, before any position outcome. Over a year the number is material against most account sizes.
The useful way to read a spread is against the distance the position is trying to capture. One pip against a 60-pip target is under two percent of the move. The same one pip against a 5-pip target is twenty percent, and no method survives paying a fifth of its target on entry.
A tight spread is not the same as liquidity
The quote shows the best price and, on venues that publish it, the size available there. Those are different pieces of information and only one of them is usually looked at.
An instrument can show a narrow spread with very little size behind it. The first small order fills at the quote and the next one does not, because there was nothing left at that level.
This matters most when closing. Entering can be patient and worked in pieces; exiting under pressure frequently cannot. The size that matters is the size available when you need out, not the size displayed when you are comfortable.
When spreads widen
Spreads are not fixed. They widen when market makers face more uncertainty: around scheduled data releases, in the hours between the New York close and the Tokyo open, and during any disorderly move.
The mechanism is worth understanding rather than memorising. A market maker quoting both sides is exposed to whoever knows more. When the chance of being on the wrong side of informed flow rises, the compensation for quoting rises with it, which is the spread widening. In extreme conditions they stop quoting altogether.
A position entered during a spread expansion starts further behind. A stop-loss placed close to entry can trigger on the spread alone, without price reaching the level on the chart, because the stop executes against the bid or ask rather than the mid price.
Slippage and market impact
A market order fills at the best available price, which is not always the price displayed when the order was sent. In fast conditions the difference is measurable.
Two separate things cause it. Slippage is the market moving between sending and filling. Market impact is the order itself consuming the book, which is a function of your size against available depth rather than of speed.
Instruments with deep liquidity fill close to the quote. Thin instruments, small-capitalisation equities, and any market during a news release fill further away. A size that fills cleanly in normal conditions may not during a repricing, which is a reason to size against the worst conditions the position might have to be closed in rather than the best.
Key takeaways
- Buying at the ask and selling at the bid means every position opens below break-even.
- Read the spread against the distance you are trying to capture, not in isolation.
- A tight spread with no depth behind it is not liquidity. The size that matters is the size available on exit.
- Spreads widen when the risk of quoting rises: data releases, thin hours, disorderly moves.
- Stops execute against the bid or ask, not the mid price shown on a chart.
Common mistakes
- Placing a stop so close to entry that normal spread movement triggers it.
- Comparing strategy results without including spread cost per round trip.
- Reading a narrow spread as depth without checking what size sits behind it.
- Sizing against normal conditions when the exit may happen in abnormal ones.
Knowledge check
OptionalRelated
- Orders and executionMarket Foundations
- How financial markets workMarket Foundations