/Bid and Ask: Understanding the Difference

Bid and Ask: Understanding the Difference

If you want to be a penny stock trader, there are some basic concepts you need to know inside and out — that includes bid and ask.

Some people find this confusing, but it doesn’t have to be difficult. Even if you’ve never traded stocks, I’d bet you’ve used the concept of bid and ask.

By the way, this post will give you a good basic understanding of bid and ask. But if you’re ready for in-depth training, apply for the Trading Challenge. You’ll understand bid and ask if you follow the lessons and study hard.

Back in junior high, along with my best friends, I devoted my entire being to trading baseball cards. We read the “Beckett Baseball Card Monthly” religiously. We studied prices, trying to guess how they would move.

That’s when my tendency to be what I lovingly call a degenerate trader all started. I loved the action as much as I loved making a profit. I learned a lot about supply versus demand, and how that can affect prices. Bear with me, this also relates to bid and ask.

A lot of parents of teens in the ‘80s were teens themselves in the ‘50s and ‘60s. Those who were collectors were painfully aware that they’d lost out on a huge opportunity when their parents tossed their old baseball cards. So in the ‘80s, when you could get full sets in mint condition, they bought them up and stashed them away for later.

Here’s the problem: The ‘80s cards were mass produced. Collecting complete sets was easy. To this day, those cards aren’t worth much compared to the cards of the ‘50s and ‘60s. Why? Scarcity. A lot of parents tossed those old baseball cards when their kids went off to college, and that keeps the prices of older cards high.

I know, I know … What the heck does this have to do with bid and ask on the stock market?

Download the key points of this post as a PDF

Bid and Ask

When my friends and I traded, we based our trades around the prices we found in the “Beckett” magazine. We were always angling to get the upper hand in any deal. To make a trade there would be an offer (bid) and a counter offer (ask). It was rare to complete a trade without a little haggling.

When I bought cards, it was the same. The owner asked for a certain amount, and I either paid that amount or made an offer. Sometimes we’d strike a deal based on my offer. Other times I had to pay what the owner asked or walk away disappointed.

Bid and ask in the stock market are similar. Here’s how it works:

  • Bid: Bid is the highest current price on record that a trader is willing to pay for one share.
  • Ask: Ask is the current lowest price on record that a trader is willing to accept for one share.

It’s important to understand that there are other bid and ask prices in the order book or queue. They’re waiting for the current price to get knocked off by an order execution or another trader to offer a higher bid or a lower ask.

To understand bid and ask, you have to be clear on the basics of how buying and selling work. I bet you’ve been buying and selling ever since you had that first quarter or 50-cent piece in your pocket.

Let’s take a look at an example to put bid and ask into a familiar context …

How Buying and Selling Work

bid-ask-tim-sykes
© 2018 Millionaire Media, LLC

Jenny wants to learn to trade penny stocks. She needs extra money to buy my PennyStocking Framework Part Deux course. Jenny also wants to set aside a few grand to open a trading account. She decides to start a small service business to save money for her trading education.

Jenny enjoys gardening. She cruises around her neighborhood and realizes many people could use a gardener. But even more people — good, hard-working but time-starved neighbors — simply need someone to mow their lawn. Jenny’s idea blossoms: start a lawn-mowing service as a front-end offer for her gardening business.

Jenny creates a flier on her laptop that reads:

No Time to Mow Your Lawn?

Don’t worry! I’ll do it for $10 ($15 for large lawns).

For a Perfectly Manicured Lawn, Call Jenny: 867-5309

Ask about my NEW CLIENT SPECIAL!

She then prints 100 copies and puts them up around the neighborhood. After a few days, Jenny gets a call:

“Jenny, I got your number … from a flier on my porch. I’d like to hire you to mow my lawn.”

Great news for Jenny. Her first client. Negotiations begin.

Let’s take a look at how this works in relation to bid and ask:

  • Ask: Jenny is offering a lawn-mowing service. She advertises a price of $10 but has a new-client special of 10 mows for $90, or $9 each. We’ll call $9 her ask price.
  • Bid: Jenny’s new client wants his lawn mowed. He asks about the new client special. Jenny explains the 10 mows for $90 offer. He counters with an offer to pay up front for 15 weeks at $8 per mow. His bid is $8.
  • Spread: The difference, or spread, between Jenny’s price and the client’s offer is $1. What will Jenny do?
  • Jenny’s clever. She’s calculated her costs and estimated the long-term value of a new customer. (Jenny’s angling for upsells to other gardening services so she can start trading sooner.)
  • Execution: Jenny agrees on the offer of 15 weeks at $8 per week. This is like the execution of a stock order.

Jenny does such a great job that the client hires her to plant flowers, remove leaves, and cut back shrubs before winter. Other neighbors see Jenny’s work and hire her. Jenny’s new side-business is so popular that she quickly saves the money to start trading.

Meanwhile, Jenny hires two people to staff her gardening business. She’s free to become a full-time, self-sufficient trader. She works her tail off and becomes my next top student.

I want more students like Jenny — determined, driven, entrepreneurial, and hard working.

“Jenny, Jenny … who can I turn to?” (Sorry, I couldn’t resist a Tommy Tutone reference.)

Seriously, a lot of potential students mention not having the money to invest in their education. I just gave you a blueprint on how to earn extra money. That’s one of the many possible ways you could set aside extra money to get started.

Buying and Selling Stocks

In essence, buying and selling on the stock market is the same. The bid and ask prices are recorded, you place an order, and the order gets executed.

However, a market maker might be required to keep things moving. A market maker helps maintain liquidity by filling orders, sometimes from their own ‘inventory.’

When to Focus on Bid and Ask Prices

Now we’re getting to the good stuff. But this is where it can get a little complex. So rather than go into great detail here, I’ll give a simple explanation and then give you my usual recommendation. You got it … you need to study.

Quick note: Nearly everything you need to know about bid and ask is in “The Complete Penny Stock Course” by my student Jamil Ben Alluch (I wrote the forward). That includes an in-depth explanation of what I’m about to share with you.

At the most basic level, you should focus on bid and ask when the price is:

  1. Close to key support or resistance levels.
  2. Close to your planned profit or loss targets.
  3. Close to daily highs or lows.

As you get deeper into your trading education, you’ll learn about Level 2. Briefly, Level 2 is a data feed that provides real-time trade details. You can use it to see the order book or queue (including bid, ask, and order size) for any given stock.

With Level 2, you can see what I call a wall of buyers, a wall of sellers, and a Mexican standoff (simultaneous walls of buyers and sellers). When you combine Level 2 indicators with key support and resistance it can help you follow your trading plan.

Now you know the basics of buying and selling, bid and ask. But did you know there are different types of stock orders? This is crucial information. Let’s check it out …

Types of Orders to Execute Bid and Ask

#1 Market Order

When you place a market order, your order gets executed at the recorded price at the time of execution. This applies to both buying (you pay the current ask) and selling (you receive the current bid).

Here’s an example: You place a market order to buy 100 shares of Blink Charging Co. (NASDAQ: BLNK). When you place your order, the latest bid is $3.83 and the latest ask is $3.85. But your order goes into a queue called the book. The amount you actually pay is determined by the ask price when your order gets executed.

Here’s what you might see (we’ll leave Level 2 out of it for simplicity):

bid-ask-differences
StocksToTrade showing Bid and Ask, Time and Sales.

With a market order, you pay the ask price — the lowest recorded available price — when your order reaches the front of the queue. For the sake of simplicity, let’s say your order gets filled instantly. You buy 100 shares of BLNK at $3.85 (the current ask).

As a penny stock day trader, I never trade using market orders. The reason is that I don’t have control over the purchase price.

If the price moves the wrong way fast, my order could get executed far outside my planned trade setup. There’s also the potential for price manipulation by market makers.

#2 Limit Orders

This is the type of order I use and teach my students to use. With a limit order, you set the price at which your order will be executed. Your broker has to execute your order at your limit price (or better). If the order can’t be executed at your limit price, it won’t get executed.

Plus, you can cancel a limit order at any time before it gets filled. This means you can decide to wait for the price to come to you. Or, if bid and ask prices are moving away from your limit, you can cancel.

A limit order means your position might not get filled (or might get partially filled). But it also ensures that you won’t trade at a price outside your trading plan.

Quick note on limit orders: There’s a slight delay and you’ll pay higher commissions compared to a market order. That’s because a limit order takes more work for the broker to execute.

#3 Understanding Spreads

understanding-spreads
Kaboompics .com/Pexels.com

As explained in our example of ‘Jenny the entrepreneur turned Trading Challenge top student,’ the spread is the difference between bid and ask prices.

If you look at the BLNK chart example again, the bid and ask spread is 2 cents. As a percentage of the share price, 2 cents isn’t much. A close spread is a sign of relative stability in a stock’s price. The bigger the spread, the greater the volatility.

A market maker is a kind of broker or dealer who brings liquidity to the market by filling orders. They make their profit by taking advantage of the bid-and-ask spread. With the development of electronic trading, most orders are filled by a matching engine. A matching engine matches buy and sell orders electronically.

Look at the BLNK chart again — now check out the ‘Time and Sales’ window. The white transactions are orders filled between bid and ask at the time of execution. This can happen for a number of reasons. One common reason is that a market maker purchases or sells shares between the bid and ask to help maintain liquidity.

So how does the market maker profit from the spread? Good question.

Let’s go back to that chart. You place a market order to buy 100 shares of BLNK, executed at the ask price of $3.85. At the same time, a seller jumps in and sells 100 shares, executed at the bid price of  $3.83. In this example, the market maker profits on the 2-cent spread.

Market makers take on risk by holding shares to buy or sell. They also display both buy and sell quotes.

This is the same principle as going to a currency exchange shop in Europe to change dollars into euros. These shops display a board that lists various currencies with ‘We Buy At’ and ‘We Sell At’ columns. They profit on the spread between the two (with added exchange commissions, of course). The prices on their board are bid and ask prices.

#4 Bid and Ask Size

The bid size is the number of shares a buyer (or market maker) is willing to buy at the bid price. The higher the bid size, the more shares traders are willing to buy at that price.

The ask size is the number of shares a seller is willing to sell at the ask price. The higher the ask size, the more shares that are available from traders who want to sell at that price.

Both bid and ask sizes can also limit the number of shares you can buy at any given price. This is important. When I talk about getting partial execution, this is what I’m talking about.

Let’s say you try to buy 5,000 shares of a stock at $1, but the ask size at $1 is 2,000 shares. The next lowest ask is $1.05. For you to buy all 5,000 shares you’d have to pay more for the 3,000 extra shares you need to fill your order.

To make this super clear, since you’re using a limit order, your order will be partially executed. You get the 2,000 shares at the price ($1) you want. If you’re buying into a multi-month breakout and your trading plan allows for it, you can buy the other shares at a higher price. But you have to place another limit order at the higher price.

Importance of Bid-Ask Size

Bid and ask size are important for a few reasons:

  • If there’s a discrepancy between the total bid and ask sizes, filling orders becomes difficult. In most cases, market makers or specialists will step in and buy or sell shares to maintain liquidity. Otherwise, the imbalance can force a halt in trading.
  • Bid and ask sizes give you an indication of supply versus demand. If bid sizes are higher than ask sizes, the buyers have strength at a given price. The opposite is true for ask sizes: If ask sizes are higher than bid sizes, sellers have strength at a given price.

Bid-Ask Spread in Options

The bid-ask spread in options can be much larger because options tend to be less liquid. For those unfamiliar with options, they are a financial instrument that gives the right to buy shares at a certain price before a certain date. Options are usually more liquid if the underlying stock is liquid.

Options are an entirely different game from penny stocks. They aren’t for me. But there is one thing that options trading and trading penny stocks have in common: Preparation is key.

So while I’d rather see you learn to trade penny stocks, if you choose to get into options then educate yourself and study like crazy.

See our posts:

  1. Day Trading Options Guide: How to Find Better Options Trades
  2. Binary Options Trading Guide: How to Trade Them Properly
  3. Options Trading Basics: Strategies and Examples of How it Works

And for a real good comparision between pennys stocks and options:

Take Advantage of StocksToTrade Features

It’s no secret that I’m a huge fan of StocksToTrade. I helped design the platform. It has so many cool features I could easily double the length of this post.

Since this post is about bid and ask, I want to share a video (3 minutes and 13 seconds of pure awesomeness) featuring my colleague Tim Bohen. Tim is the lead trainer for StocksToTrade.

Watch the video because the Level 2 Book Entry bar is ALL about bid and ask live data.

Once you set up your StocksToTrade account, make sure you spend time watching Tim Bohen’s training videos. They can help reduce the time it takes you to get familiar with the platform. His videos are excellent.

By the way, get your 7 Day Trial here:

https://stockstotrade.com/7daytrial/

Conclusion

Bid and ask for stocks is the equivalent of an offer and an asking price. These are terms you should not only know but understand thoroughly. Study, study, and study some more.

I suggest you get a StocksToTrade subscription if you don’t already have one. Then spend some time paper trading to learn how things work. Get a Level 2 subscription — that way you can see all the action and start to understand entry and exit points better.

I also encourage you to apply for the Trading Challenge. That’s where I teach you how to take advantage of the information in this post.

What kind of trader are you? How do you use bid and ask in your trading setups? Let me and your fellow traders know. Leave a comment!

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