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Bid Ask Spread (Formula, Examples) | Calculate Bid-Ask Spread - YouTube
Channel: WallStreetMojo
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hello everyone welcome to the channel of
Wallstreetmojo friends today we are
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going to learn a concept that is known
as bid-ask spread formula bid-ask spread
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is useful not in terms of only in bonds
but it is also used in forex so let's
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get into the nitty-gritty of this
particular topic as you can see bid-ask
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spread it's written difference between
the price of the seller asked and the
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price with the buyers bid for the
bidders friend is the difference between
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the bid price of the security and ask
price okay that's called the offer price
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so it represents but basically the
difference between the highest price
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that's that a buyer is willing to pay
for a security and at lowest price that
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a seller is willing to accept so it's a
basically transaction that occurs either
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when a buyer accepts the ask price or a
seller takes the bid price in a simple
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terms I can say a security will trend
upward in a price when the buyer
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outnumbers the seller so as the buyers
bid the stock higher conversely a
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security will will trend low and prices
when the sellers outnumbers the buyer
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and as the supply of demand imbalance
will will force the sellers to lower
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their offer price so the bid-ask spread
is a very important consideration for
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most investor when trading securities
since basically it is hidden cost
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incurred when trading any financial
instrument stocks bonds commodities
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futures options and foreign
exchange let's see what are the spread
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considerations see there are
following I mean number of points that
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needs to be borne in mind with regards
to bid are spread spreads are determined
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by liquidity so as well as if it's
supply and demand for a specific
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security the most liquid or widely
traded security tend to have a narrow
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spill spreads as long as there is no
major imbalance between the supply
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and demand if there is a significant imbalance
and lower liquidity the bid-ask spread
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will expand substantially so
spreads on the US stock have narrowed since the
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advent of the dissimulation in 2001
prior to that date most US stocks
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coated in the fractions of 1 is the 16th
of the dollar or that is closer to 6.25 cents
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so most stocks now trade
at the bid are spread well below
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the level bid-ask spreads it represents
a cost that is not always apparent to
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the Lowest investors while spread cost
may be relatively insignificant for
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investors who do not train it frequently
they can represent a bigger cost for
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active traders who make numerous trader
daily spreads widened during the steep
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market declines because of the
supply-demand imbalance as sellers hit
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the bid and the buyer stay away in
anticipation of the lower price as a
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result the market makers they widen the
spread of and that is only because of
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the two reason the first to mitigate the
higher risk of loss during the volatile
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times and second to suit the investors
from trading during such times and as a
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larger number of the trades increases
the risk to the market makers has been
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caught on the wrong side of the trade
now let's get into the bid-ask spread
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formula I mean bid-ask spread is a very
important consideration in the stock
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trading and here is the bid-ask spread
formula that you can use to calculate
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the spread so what is exactly the
bid-ask spread it is basically the ask
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price of the security less the bid price
of the security so I can say the bid-ask
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spread is equal to you can say the ask
price of the security less the bid price
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of the same security this is basically
the formula for the bidask spread see
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the remember the ask price will always
be higher ask price will always be
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higher than the bid price a very simple
way to think that bank will will always
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sell any security or forex at a higher
price and will buy at a lower price the
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difference is the profit
so the ask
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is the offer price and the bid that is
the purchase price so the offer price
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has to be greater than the purchase
price as simple as that
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let's stick and get into one example you
know a practical example okay that that
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will really help you do to get into the
know of this particular concept let's go
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into the example let's say Tim decides
to buy few stocks but the excess savings
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he has I mean his friends brown as
long-term investors brown ask Tim to
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find out the spread of the company M
before he invests in into it and brown
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says that understanding bid ask spread will
help Tim in future investments so Brown
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has provided the following details as
you can see the bid-ask on the assumed
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one of the stock is close enough 200 and
the ask price is 102 since Tim is a very
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new investor as a novice investor it
doesn't understand I mean what the
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spread is so he finds out the formula and
applies it and and in one go he is able
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to find out the spread of the stock of
the company here the calculation will be
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spread is equal to the ask price of the
stock you say spread will be equal to
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the ask price I'll just write spread
over here the ask price of the stock
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less any bid price of the same stock
less bid price of the same stock okay so
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let's put some numbers over here it will
be hundred and two less 100 that
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will give her the other answer comes us
2 so our answer is spread is equal to
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2 so as for that as for Tim the spread
of a stock of a company of em is 2 now
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let's get into the explanation of the
bid-Ask Spread formula if you want to
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make your mark as an investor you need
to know the basic of the stock trading
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spreading is a concept that every
investor needs to understand when a
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stock is sold it has two parties one is
called buy another is called sellers the
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buyers tell the sellers that they are
ready to pay a price for a stock we call
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it what a bid price so the seller also
tells the buyer that they can sell the
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stock at a price so the price sellers
ask is
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always litter little higher than the
price of the buyer are ready to pay and
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the price sellers ask for a stock is
called the ask price in bid ask formula we
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find out the difference between the
price of the seller asked and the price
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of the buyers bid in this particular
example of Reliance Industries Limited
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now as you can see from the bid-ask
spread example of Reliance Industries
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for a buy quantity of close enough to 47
the bid price is 925.30
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and as you can see whereas
the asks price is close enough the bid
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price is 925.25 and the self that is the
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offer price of the ask price is 925.30 so the bid ask that is
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the offer price less the bid price okay
will give us the bid ask spread that is
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0.05 so as an investor you may ask why
the seller always ask for the higher
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price of a stock it is because they keep
a little profit for themselves but but
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but that's not the only thing that's
included in the ask price along with the
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Commission of the broker the spread also
includes number of fees got it
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and that fees will actually will boost
up the value of the bid-ask spread
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remember one thing see the spread on the
US stock have really narrowed since in
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since 2001 and the spread has widened
during the steep market declines because
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the supply-demand imbalance as a seller
and it hits the bid the buyer stay away
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in the anticipation of the lower price so
as a result the market makers they
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whiten the spread for the two reason first
to mitigate the higher risk of loss and
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second as we know that the larger number
of the trades increase the risk to the
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market have being caught on the
wrong side of the trade now most forex
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trading at a very retail level is done
using a great deal of leverage because
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of which spread cost of percentage of
the traders equity and it can be quite
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high in the like for a quick calculation
of the cost of a spread as a percentage
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of your margin or equity simply multiply
the spread percentage by the degree of
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leverage for example if the spread in
our case was let's say five pips that is
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the five points so we can say we just
need to add those 0.05 value in that
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particular case let's take one more
example and get into the core of this of
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this concept now consider the example of
an equity option trade let's say you buy
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a short term call option on a stock XYZ
as you are bullish on it so the stock is
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trading at let's say 31.39
and this is the ask price that is 31.40
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and the one month
call are trading at let's say 32
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and one month $32 call are trading at
0.72 and 0.73 so over here the bid ask spread okay in
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in this case is just a penny but in a
percentage term it is
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sizable to close enough to 1.37 so over here the underlying
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stock is also trading within the penny
spread but in percentage terms this
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ferret is much more smaller I mean smaller
at a rate of 0.032% because of
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the higher price of this stock as
compared to the option an option trader
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however is unlikely to be deterred by
the significantly higher spread
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percentage on a call since the main
motivation for buying a call option is
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to participate in the underlying stock
at once while putting down the fraction
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of the amount required to buy the stock
now let's get into some more details on
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this first bid ask spread if I mean use
limit orders and investors or trader is
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generally better off using the limit
orders which allows one to place a price
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limit for a purchase or sale of a
security rather than the market orders
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which are filled at the prevailing
market price in fast food markets the
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use of the market order can result in
higher president desired for our
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purchase and a very low price for the
sales for example if a prevailing price
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of a security that you wish to buy is
lecture 9.95 and it is
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$10
okay rather than buying a stock at ten
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you could consider bidding at 9.97 for it so while the possibility
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of getting the stock 3%
cheaper is offset it by the risk that
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they Stock may move in the price so you
can always change your bid price if
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required
so at
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you will not be buying the stock a 10.05
because you entered the market order and
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stock moved up in the interim second
avoid the liquidity charges the use of
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the limit orders also enhances the
liquidity in the marketplace so this
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enables you to avoid the liquidity
charges imposed by most of the
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electronic communication networks by for
using the market liquidity which occurs
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when you use the market orders executed
at the prevailing bid ask pricing
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evaluate the spread percentage that's the
third thing as an example earlier
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demonstrate bid ask spread can be quite
significant if you are using margin or
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leverage evaluate the spread percentage
since the 5%
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on a $10 stock is much greater in
percentage terms then if a 5%
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spread on the $40 stock
fourth shop around for the narrowest
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spreads
this is especially applicable to the
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retail Forex trader who may not have the
luxury of the 1% spread
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available to the interbank and
institutional Forex trader shop around
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for the narrower spread among many forex
brokers who specializes in retail
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clients tell to improve their order
trading success so conclusion pay
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attention to the bid ask spread since it is
the hidden cost incurred in trading any
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financial instrument this why bid
spread can also erode the trading
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profits and aggregate losses so the
impact of the bid-ask spread can be
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mitigrate by using the limit orders
evaluating the spread percentage that
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was the second thing and the shopping
around the narrowest spread thank you
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